Net worth is the difference that exists between what is owed and what assets are in the possession of the individual, business, or other entity. Calculating this involves totaling the amount of all debt obligations, and subtracting that figure from the total worth of all assets. When the cumulative value of all the assets exceeds the total of all liabilities, it can be said that a positive net worth exists.
When determining the net worth, it is important to include all assets in the calculation. Examples of assets include cash on hand, real estate holdings, stocks and other investments, and major items such as vehicles. To properly estimate the value of various assets, it is important to make use of the current fair market value, rather than going by the price paid at the time of acquisition.
Assessing the liabilities properly is also important. Liabilities include such items as the outstanding balance on a mortgage or car payment, total credit card debt, and the remaining balance on any other types of loans. It is important to account for each asset and each liability.
Understanding your current net worth is very important. If it would be possible to pay all your current debt obligations by liquidating your assets, that is an indication of relatively stable financial health. When your assets are more than enough to pay off your current debts, that means you are even more stable from a financial point of view. The goal for many people and businesses is to operate in a situation where there is a positive net worth.
Having an accurate assessment of net worth is helpful in several ways. First, it is important that your current liability load does not exceed the current value of your assets. If you owe more than you own, that is one indicator that you are not a particularly good credit risk. Banks and other lending institutions may hesitate to offer you the best rates available, since there is more risk involved in lending you money.
Another reason that understanding your net worth is important is that it helps provide a starting place with your financial planning. If you know that you barely have enough assets to cover your current debt load, that is a signal you should put off any major purchases until you have paid off a few debts. From this perspective, periodically assessing your assets can help you understand where you are today and project when you will be in a position to purchase that new car without creating a great deal of financial hardship.
Calculating your current net worth is also helpful in identifying any surplus you may have that could be invested or placed into interest bearing accounts. Because you are reasonably sure those assets will not be required to pay off your current debts, you are free to make use of those assets to plan for later years. Without assessing your finances from time to time, you may overlook one or more assets that could be converted and used to create a higher yield that ultimately is in your best interests.