Last Updated on Jul 19, 2022 by Anjali Chourasiya
The wealthiest person on this planet is Elon Musk, having a net worth of $215.6 bn. But, how do we calculate this net worth? Is it what the person earns or what their company earns, or both? In this article, let’s dive into what net worth is, its importance, tangible and intangible net worth, how to calculate it, and the ways to improve your net worth.
Table of Contents
What is net worth?
Simply, net worth is the difference between assets and liabilities. It provides a snapshot of your financial health and the worthiness of your mortgages and lines of credit. You have a positive net worth if your assets are higher than your liabilities. Conversely, if your liabilities exceed your assets, your net worth will be negative.
Like in the stock market, your net worth tends to fluctuate. However, similar to the stock market, the overall trend matters. Ideally, your net worth should continue to grow with age as you pay off debt, acquire more assets, build equity, and so forth. It is also normal for your net worth to fall if you begin to tap into your savings and investments for your retirement.
What is tangible net worth?
For specific applications, your basic net worth calculation may not be sufficient. Hence, it would be best if you had your tangible net worth. It is similar to your basic net worth but subtracts the value of any intangible assets such as goodwill, copyrights, patents, and other intellectual property. Tangible net worth uses physical assets to determine your worth.
Tangible net worth is essential for corporations to determine their actual net worth using physical assets. If the businesses cease to operate or are being sold, they use their tangible net worth to assess their liquidation value. You can calculate your tangible net worth to quantify how you are doing financially or evaluate your financial progress over time.
Understanding your assets
An asset is any resource with economic value owned by an individual, corporation, or country with the expectation that it will generate a positive, future financial benefit. They are nothing more than possessions that you could exchange for cash.
Assets can be broadly categorised into current assets, also known as short-term assets, fixed assets, financial investments, and intangible assets. Some examples of assets are your home, land you own, financial securities, artwork, gold, silver, jewellery, your checking account, machinery, cash, equipment, and more.
Understanding your liabilities
A liability is something you or your company owes. It is settled over time through transferring economic benefits, including money, services, or goods. Liabilities are financial obligations that result in future sacrifices of economic benefit to another person or company. With the information of a company’s liabilities, it is possible to understand its overall liquidity and capital structure.
The primary classification of liabilities is based on their due dates, such as current liability and long-term liability. Current liabilities are due within a year. It includes unpaid bills, interest expenses, income tax amounts, short-term loans, and more. In contrast, long-term liabilities include outstanding bonds, deferred tax amount, mortgage, long-term debt, capital lease, and more.
There is one more type of liability, known as a contingent liability. It is a special category of liability, which may or may not arise depending on the outcome of an uncertain future event. One of the most common examples of contingent liability is legal liabilities.
Why is net worth important?
Knowing your net worth can help you discover your current financial status and plan for the future regardless of your financial situation. When you review your net worth statements over time, it can help you determine where you currently are and how to get where you want to be. Here are reasons that prove the importance of your net worth.
Spending in budget
When you are aware of your net worth, you can easily identify areas where you spend too much money. You can save yourself from accumulating too much debt. Knowing your net worth also helps you keep your wants and needs in check.
Pave your way to financial freedom
You can develop a plan to pay off your debt by reviewing your assets and liabilities. Moreover, it helps you plan your retirement by helping you manage your cash flow wisely.
Keeps you on track
Your net worth figure keeps you on track with your financial goals. If your net worth figure shows you are on your way to achieving your financial goals, it motivates you to continue what you are doing. Conversely, it can give you the motivation to save and invest your money in case your net worth statement is not in line with your goals.
Net worth formula
The net worth formula is equal to the difference between assets and liabilities. It can be derived by subtracting the total liabilities from the total assets of the company.
Net worth = Total assets – total liabilities
- If net worth is greater than zero, it indicates good financial health.
- If net worth is less than zero, it indicates negative financial growth.
Examples using the net worth formula:
Suppose, your assets and liabilities are as follows.
| Assets | Liabilities | ||
| Properties | Rs. 45,00,000 | Property loan | Rs. 12,00,000 |
| Savings | Rs. 7,00,000 | Car loan | Rs. 3,00,000 |
| Stocks | Rs. 20,00,000 | Education loan | Rs. 80,000 |
| Insurance | Rs. 12,00,000 | Long-term debt | Rs. 9,00,000 |
| Jewellery | Rs. 50,000 | ||
| Cars | Rs. 5,00,000 | ||
| Cash and cash equivalents | Rs. 40,00,000 |
Total assets value = 45,00,000 + 7,00,000 + 20,00,000 + 12,00,000 + 50,000 + 5,00,000 + 40,00,000 = Rs. 1,29,50,000
Total liabilities = 12,00,000 + 3,00,000 + 80,000 + 9,00,000 = Rs. 24,80,000
Using the net worth formula:
Net worth = Assets – liabilities = 1,29,50,000 – 24,80,000 = Rs. 1,04,70,000
Hence, the total net worth according to the assets and liabilities in this example is Rs. 1,04,70,000. It is positive, which indicates good financial health.
4 ways to increase your net worth
The idea of increasing your net worth might seem challenging, but it doesn’t necessarily mean it is. The process will likely take years, but with the correct methods, you can put the right system into place. Here are 4 ways that might help you increase your net worth and meet your financial goals.
Review your liabilities
Reviewing your liabilities gives you an insight into how much debt you owe and in what form (mortgage, credit card debt, loan payment, and more). The first step to improving your net worth statement is reducing debt.
Consider making changes to your payment plan. You can try paying your debt weekly or biweekly instead of monthly. It might help you reduce the principal amount sooner, reducing the total amount of interest you have to pay.
Review your assets
You may not get the exact value of your assets or what they may be worth in the future, but you can get an estimated figure. While reviewing all your assets, make sure to include all asset classes. Remember, every penny counts when you add up your assets. Reviewing your assets will give you an insight into your current financial direction, and you can amend your investment plan accordingly.
Cut-off expenses
The more money you save, the more you accumulate in your net worth. It is always a good idea to review your budget. Have a look at your current expenses, and find areas where you can cut back, such as cancelling subscriptions of magazines you don’t read anymore or skipping everyday outings. Find annual costs that are bringing down your net worth. Eliminate them and commit to saving and/or investing to add to your net worth.
Amplify your emergency fund
When you have an emergency fund, you can avoid unexpected expenses that take the form of high-interest debt. Getting trapped in this never-ending, vicious debt cycle pulls your net worth significantly down. Hence, an emergency fund can help you avoid the debt cycle, increasing your net worth.
In a nutshell
In the financial world, your net worth determines your status. It also indicates your financial health. Hence, taking control of your net worth, putting efforts towards increasing your assets and decreasing your liabilities, and devising a solid financial plan is worth your time and effort. Using the methods mentioned in the article to increase your net worth, you can devise a financial plan according to your requirements and situation. It is always worthwhile to take help from a financial advisor.
FAQs
1. What is liquid net worth?
Liquid net worth only counts the assets that can quickly turn into cash. For instance, the stocks you hold can easily be sold and converted into cash. However, the value of your home is much harder to tap right away.
2. What is the difference between net income and net worth?
Your net income is your income after taxes and payroll deductions. In comparison, your net worth is the total value of everything you own, minus your debts.
3. How often should I calculate my net worth?
There is no one rule that suits all when it comes to calculating net worth. You can calculate it quarterly or annually, depending on your preference. Nevertheless, it is suggested that you calculate your net worth after a big purchase or sale, such as a car or a house.
As an insatiable reader and learner, I’ve spent the last two years exploring the world of finance. With my creative mind and curious spirit, I love making complex finance topics easy and fun for everyone to understand. Join me on my journey as we navigate the world of finance together!
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