What is Net Worth?
- An entity’s net worth (also referred to as “net asset value” or “NAV”) is the value of the entity’s assets minus the value of its liabilities.
Net worth = total assets – total liabilities. - Net worth
The net worth of any entity (a business, a NGO, a person, or any other legal entity), is the amount of money that will remain, if all the entity’s assets are sold and all the entity’s debts are paid.
Net worth is a good measure of an entity’s actual value.
Net Asset Value per Share
- The net asset value per share, or NAV per share, is the net worth of one share in an entity.
NAV per share = (total assets – total liabilities) / total number of shares. - Net asset value per share
If an entity is divided into shares, e.g. a publicly listed company, it is useful the calculate the net asset value per share.
This will give you a good indication about whether the company is over valued or under valued by the market.
A company with a NAV per share that is significantly lower than the current share price is likely to be over valued.
Net Worth and Creative Accounting
The only fool-proof way to get a 100% accurate figure of an entity’s net worth, is to sell all the entity’s assets for cash, pay all the entity’s creditors and count the money that remains.
The problem with this approach, of coarse, is that you’re effectively destroying the entity’s functionality.
To determine the net worth of an entity, while keeping the entity in tact, you need to work with estimates. This is where there are opportunities for people to get creative.
Owners of an entity often over-estimate the value of their assets, for various reasons, be it sentiment, a lack of knowledge, or outright dishonesty.
Similarly, potential buyers of an entity often under-estimate the value of the entity’s assets, mainly because they’re afraid of paying too much for the entity.
The best way to get an accurate estimation of an entity’s net worth, especially if it done for the sake of a purchase and sale transaction between a buyer and a seller, is by getting an impartial and competent 3rd party, who have nothing to gain or to loose through the transaction, to do an assessment of the entity’s net worth.
Positive and Negative Net Worth
- An entity has a positive net worth, if the total value of the entity’s assets are more than the total value of the entity’s liabilities.
- Positive net worth
If an entity’s assets are worth more than the total debts the entity has, it has value and is said to have a positive net worth.
- An entity has a negative net worth, if the total value of the entity’s assets are less than the total value of the entity’s liabilities.
- Negative net worth
If the entity has more debts (liabilities) than it’s assets are worth, the entity is said to have a negative net worth. In this case, the entity is effectively worth less than nothing.
It is still possible for an entity with a negative net worth to be viable and even to be sold for a positive amount of money.
This is because the net worth of an entity doesn’t take into account things like potential future earnings or opportunities, e.g. contracts that were just negotiated, positioning of a company for future growth, etc.
It is often the case that a new business venture will have a negative net worth. Most new businesses require a lot of money up front to setup and establish itself in the market place, while they only start to make that money back a few years later.
This is one reason why new businesses are risky to invest in and stressful to own and run. A bad month or two and a couple of missed loan payments can easily destroy a new venture.
This definition is part of the Dictionary of Financial Terms. If you want to receive a notice every time a new definition is published, you can subscribe to Liberta.
