Net worth: Overview, definition, and example
What is net worth?
Net worth refers to the total value of an individual’s or business’s assets after subtracting liabilities. It is a key financial metric used to assess financial health, stability, and overall wealth. A positive net worth means that assets exceed liabilities, indicating financial strength, while a negative net worth suggests financial distress, as liabilities surpass assets.
For example, if a business has $8 million in assets and $5 million in liabilities, its net worth would be $3 million ($8 million - $5 million).
Why is net worth important?
Net worth is important because it provides a clear picture of an entity’s financial position. It is often used by lenders, investors, and financial analysts to assess creditworthiness, risk, and long-term sustainability. A strong net worth enhances a company's ability to secure loans, attract investors, and make strategic investments, while a declining net worth may signal financial trouble.
For businesses, maintaining a positive net worth is essential for growth, financial stability, and investor confidence. For individuals, a growing net worth indicates strong financial management and future security.
Understanding net worth through an example
Imagine a business applying for a loan. The lender evaluates the company's balance sheet to determine its financial stability:
- Total assets: $12 million (including cash, real estate, and inventory)
- Total liabilities: $7 million (including loans and outstanding obligations)
- Net worth = $5 million ($12 million - $7 million)
Since the company has a positive net worth, the lender considers it financially stable and is more likely to approve the loan.
In another example, an investor considering two potential acquisitions compares their net worth:
- Company A: Assets of $20 million, liabilities of $8 million → Net worth = $12 million
- Company B: Assets of $15 million, liabilities of $12 million → Net worth = $3 million
Since Company A has a stronger net worth, it appears to be the more financially stable investment option.
Example of a net worth clause
Here's an example of how a net worth clause may appear in a contract:
“The Borrower shall maintain a minimum Net Worth of [$X] during the term of this Agreement. If the Borrower’s Net Worth falls below the required threshold, the Lender reserves the right to request additional financial assurances or declare an event of default.”
Conclusion
Net worth is a fundamental measure of financial health, affecting lending decisions, investment strategies, and corporate stability. Maintaining a strong net worth helps businesses build credibility, secure funding, and manage risk effectively. Including a net worth clause in financial agreements provides assurance that an entity remains financially stable, reducing uncertainty for lenders and investors.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.