Besides the financial performance, profitability, net assets, capital, etc., the net worth calculation is also an important consideration for any business entity.
The purpose of some financial metrics is to report different aspects of a company’s performance. For instance, the net profit tells about the growth in recent times.
The current ratios tell about the short-term liquidity of the organization. Similarly, net worth is also a measure that tells about the net value of a business.
Net worth is one of the multiple metrics that internal and external stakeholders of a company use to value a company. Investors are the most common users of such information. They evaluate the market value metrics like market capitalization, total value, debt to equity ratios, etc.
The implication of net worth is not just limited to corporations and business entities. Instead, net worth can be calculated in personal finance as well. However, our main focus in this article will be discussing the net worth of a corporation. We will talk about its implications and how to calculate the net worth.
Types of Net Worth
As mentioned, the net worth implications are not limited to corporate finance, but net worth can also be calculated for personal finance. We can categorize net worth into two types: net worth in business and personal finance.
The main difference is that assets are recorded at the current market value in an individual’s net worth. However, the historical costs minus any depreciation of the assets belonging to a corporation are recorded when calculating the net worth of a business.
Net Worth In Personal Finance
The net worth in personal finance can be defined as,
The net worth of an individual is the difference between a person’s assets and liabilities.
Personal finance liabilities can be personal loans, car loans, home loans, credit card bills, etc. In contrast, assets can be homes, cars, bank accounts, stock investments, real estate property, etc.
Net Worth In Business
The net worth in business is also called book value or shareholder’s equity. The shareholder’s equity is mentioned in the balance sheet of the company. Therefore, it is often called a net worth statement.
Similar to personal finance, net worth in business is also calculated by subtracting all the long-term and short-term liabilities from the total assets.
Generally, profitable and growing companies have increased net worth. The companies facing a decline in sales and growth will report decreasing net worth.
What Is the Net Worth Of A Corporation?
If we look at the definition in the financial dictionary, the net worth of a corporation is explained as,
Common stockholder’s equity comprising common stock, surplus, and retained earnings is the net worth.
Another definition you’ll find there is,
It is a measure calculated by subtracting total liabilities from total assets. The assets of a business are recorded at their historical cost minus depreciation and not the market value.
However, we can also define the net worth of a corporation as,
Net worth is calculated by subtracting the total liabilities from the total assets recorded at historical price minus depreciation. It indicates and reflects the company’s performance by showing how much the corporation will own after paying off all the debts and liabilities. weNet worth is a valuation technique that companies extensively use to secure investment, report financial results, or sell the business.
Formula For Net Worth
When we talk about the formula for the calculation of the net worth, the simplest formula is as follows:
Net Worth of a Corporation = Total Assets – Total Liabilities
However, there is another method for the appropriation of the net worth of a corporation. All you’ve to do is to add the share capital(equity and preference) to the reserves and surplus of the corporation. It can be represented in the form of a formula as,
Net Worth of a Corporation = Share Capital (equity + preference) + Surplus & Reserves
How To Calculate With Example
Now, let’s head to calculating the net worth by using two methods as discussed above.
Method 1: Asset and Liabilities Method
For calculation of the net worth, follow the given steps:
- Calculation of Assets
Assets can be defined as the resources owned by a business entity for profit generation. The assets are the items owned by a company that will deliver value and economic benefit in the future.
A company owns tangible as well as intangible assets that will be included to find the total assets owned by the business entity. Correct estimation of intangible assets is a significant step in the calculation of total assets.
- Calculation of Liabilities
The liabilities of any business entity are the debt obligations of a business entity. The company owes these obligations to suppliers, vendors, and employees.
The liabilities of a company include short-term liabilities and long-term liabilities. The short-term liabilities are payable within 12 months or one financial year. For more than one year, the long-term liabilities are bank loans, debt securities issued, etc.
- Calculation of Net Worth
The final step is to calculate the net worth of the corporations. It will be calculated by subtracting the total liabilities from total assets.
Net Worth of a Corporation = Total Assets – Total Liabilities
Let’s comprehend with the help of an example.
A company has current assets of USD 400,000 and long-term assets of USD 1,500,000. The current liabilities of the company are USD 180,000. The long-term liabilities of the company are USD 500,000. The shareholder’s equity of the company is USD 800,000. The surplus and reserves of the company are USD 420,000.
Method 1:
Net worth of corporation = total assets – total liabilities
Net worth of corporation = 1,900,000 – 680,000
Net worth of corporation = 1,220,000 USD
Method 2:
Net worth of corporation = shareholder’s equity + surplus & reserves
Net worth of corporation = 800,000 + 420,000
Net worth of corporation = 1,220,000 USD
Interpretation
The story doesn’t end with the calculation of net worth. The interpretation of the net worth is also a significant step because a financial metric cannot depict something about financial performance.
When we look at the net worth of a corporation, the increasing net worth will signify better financial performance and more earnings.
Similarly, the decrease in net worth shows declining revenues and financial performance. However, it might not be the case always. Let’s discuss each trend in detail.
Increasing Net Worth
When the company’s net worth is increasing YoY, it means that the company has been doing well in profits and making assets. The implications of the increased net worth are as follows:
- The net profit of the company is increasing
- Net revenues of the company are increasing
- The net assets of the company have been increased over time
- The liabilities of the company have decreased over time
- The shareholder’s equity has increased
Decreasing Net Worth
The decrease in the net worth YoY means that the company’s performance has been declining, and the net income is decreasing. The implications of decreasing net worth are as follows:
- The net profit of the company is decreasing
- Net revenues of the company are decreasing
- The net assets of the company have been decreased over time
- The liabilities of the company have increased over time
- The shareholder’s equity has decreased
Implications of Net Worth For Businesses
Regardless of your business size and nature, calculating the net worth and preparing a net worth statement gives very useful insights. Here are some of the implications of net worth for business entities:
Tracking Financial Performance
The corporation’s net worth is important as it gives a general insight into financial performance. When the business is growing, the growth is reflected in revenues and profits.
Consequently, the increase in profit is shown in the company’s net worth. Therefore, a company can track its progress by the corporation’s net worth.
Securing External Funding
When the company wants to secure external funding, the creditors and investors evaluate the company’s value, assets, and liabilities.
The net worth of the company gives insight into its assets, equity, and growth. If the net worth statement shows a strong financial position, securing external funding becomes easy as the business entity appears less risky.
A Snapshot of the Business Financial Health
The net worth statement of the business entity tells about profit, assets, shareholder’s equity, and liabilities of the asset. The balance sheet is known as the company’s net worth statement as it presents a snapshot of the business’s financial health.
If the net worth increases, it presents good financial health and vice versa. Therefore, the business entity can take corrective actions promptly.
Tracking Debt of the Company
The change in the net worth of the company also shows the change in the net liabilities. Therefore, when the company calculates its net worth, getting a perspective on changes in debt(short-term and long-term) is possible.
If the net worth is negative, it shows the assets are decreasing, but liabilities are increasing. The company can improve its debt to equity and asset ratios by tracking the debt.
Conclusion
We’ve talked about an individual’s net worth, corporation, its calculation, and implications. The business entities must pay attention to the calculation of net worth for managerial implications and tracking business performance.
