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What is Net Worth
What is net worth is important to individuals, business owners, and entrepreneurs when applying for a financing. In fact, the term net worth is what most, if not all, bankers, financial investors, mortgage brokers, venture capitals, government lending agency, and other loans managers consider the ultimate number when determining whether a loan will be approved or declined.
Net worth is what the difference is between total assets and total liabilities. What is the net worth if assets total $600,000 and liabilities equal $370,000. In this case, net worth is $230,000. As you read on, you’ll discover net worth is more complicated then this.
Net worth consists of a number of variables. Firstly, a lender will want to know all the assets you own. For the purpose of the net worth, assets can be separated into two categories; namely, current assets and fixed assets. The assets will appear in the order of liquidity which simply means the order in which the assets can be sold quickly or transformed into cash. Current assets are more liquid than fixed assets and therefore appear higher up on net worth.
Cash is the most liquid asset since it’s already in the form of cash. As a result, cash will appear first under the current assets section of net worth. The next, most liquid current assets, include stocks, bonds, accounts receivable, life insurance policies (cash surrendered value), retirement funds/plans, and other marketable securities, to name but a few.
The next part of net worth involves compiling a listing of fixed assets. Fixed assets are economic resources which have a useful life longer than one year. Fixed assets of net worth include items such as computer equipment, automotive, house, other properties and real estate, household belongings (furnishings, washer, dryer, refrigerator, range, marketable antiques, marketable paintings, etc), buildings, land and machinery, to name a few. The sum of current assets and fixed assets is called total asset.
The next consideration for net worth are liabilities; namely, short term liabilities and long term liabilities. Short term liabilities consist of debt which is due within a one year period including income taxes, accounts payable, credit card debt, and other loans/debt due within a one year period.
Long term liabilities are the next items required for net worth. Long term liabilities include debt which must be paid beyond a one year period such as a two year bank loan, deferred income tax payable, deferred credit card debt, automobile loan, five year bank loan, mortgage on house, and other mortgages payable. It is important you consider all debts as part of your net worth.
Current liabilities plus long term liabilities will equal total liabilities.
As mentioned above, net worth is what the difference is between total assets and total liabilities. Let's look at some situations to help you better understand what is net worth.
What is Net worth under these situations? Total assets equal $500,000 and total liabilities amount to $300,000. In this case, net worth is $200,000.
What is net worth if your current assets amount to $50,000, fixed assets amount to $450,000 and current liabilities total $75,000 while long term liabilities total $625,000. In this case, net worth is negative $300,000. Under this situation, a lender most likely would not extend further credit.
What is net worth if you have assets valued at $900,000, liabilities of $1,200,000 and a 50% ownership in a venture valued at $800,000. Net worth under this scenario is $100,000. That is, $900,000 less 1.2 million plus $400,000 = $100,000.
Below shows how to organize net worth into a table. It relates more towards a personal situation opposed to a business related one.
Cash $ 10,000
Retirement funds 75,000
Total Current Assets $ 130,000
2012 Automotive $ 20,000
Household Property and contents 500,000
Total Fixed Assets $ 520,000
Total Assets $ 650,000
Operating Line of Credit $ 10,000
Credit card 1 9,000
Credit card 2 4,000
Retirement investment loan 1,000
Other Short term bank loan 1,000
Total Current Liabilities $ 25,000
Long Term Liabilities
Automobile loan $ 15,000
5 year Bank Loan 10,000
Mortgage on House 400,000
Total long-term Liabilities $ 425,000
Total Liabilities $ 450,000
Net Worth $ 200,000
As discussed, net worth is what’s remaining after liabilities are subtracted from assets. In the above case, net worth is $200,000 ($650,000 - $450,000 = net worth of $200,000). Meaning, if all current assets and all fixed assets were sold, there would be enough cash to pay the short term and the long term debt. Furthermore, the net worth estimates that $200,000 cash would be remaining or left over after the sale of all the assets.
Obviously, a positive net worth is viewed as favorable when applying for financing. In essence, the lender or financial institution is more comfortable lending money to someone or a business whose assets outweigh their liabilities.
Notice in the above net worth, an asset can also be a liability. For instance, the household property and contents has an asset value of $500,000 while the mortgage on the house has a liability value of $400,000. As a result, the equity or net worth of the house alone is $100,000.
Another situation where an asset may also be a liability occurs when you have a car loan. In the above scenario, the car is valued at $20,000 which a loan owing of $15,000. As a result, the net worth on the car alone is $5,000.
There is a situation, however, where you may have a positive net worth, but unable to secure financing due to one main reason. Let’s use the following net worth situation to explain.