Formula for Calculating Net Worth

Formula for Calculating Net Worth
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Net worth constitutes a measure of the actual financial value of a person, couple, business, nonprofit or any other entity. Calculating net worth helps individuals and companies assess their finances at a specific moment in time. Various benefits come along with net worth, most of them related to setting financial goals. The formula for calculating net worth is incredibly simple, requiring nothing more than addition and subtraction. However, some hidden complexities lurk in the process.

Basics of Calculating Net Worth

Calculating net worth requires nothing more than the simplest mathematics. In abstract form, the equation for calculating net worth reads Net Worth = Assets – Liabilities. Simply explained, an asset constitutes anything of value that an individual, business, nonprofit or other organization possesses. A liability constitutes any debt owed. Net worth differs from the actual amount of money an individual or entity holds because it includes valuable assets, like property, while subtracting outstanding debts from an individual’s worth.

Factors for Calculating Net Worth

Two factors affect net worth: assets and liabilities. Assets constitute anything of value. Obvious assets include bank accounts, homes, real estate, stocks, bonds, savings bonds, mutual funds, retirement accounts, insurance policies and vehicles. Though assets such as these constitute the most obvious inclusions on the asset side of a net-worth calculation, anything of value technically qualifies, including jewelry, art, valuable musical instruments, computer equipment, expensive furniture and myriad collectible items with substantial value, from baseball cards to comic books. Liabilities constitute all outstanding debts, which include mortgages, credit cards, student loans, business loans, back taxes, medical debts and even personal loans from friends.

Complexities of Calculating Net Worth

The complexities of calculating net worth lie in calculating the total value of all assets and liabilities. Calculating liabilities generally proves the easier of these two, as all outstanding debts hold set values with set interest rates. As such, calculating the total value of liabilities requires little more than addition. The value of assets, however, exists in a constant state of flux, usually due to market trends. A home worth $250,000 in 2007 may hold a value of $200,000 in 2011 thanks to trends in real estate. Before adding up the value of all assets, you must first ascertain the actual value of an asset at a precise moment in time. This may require consulting experts in various fields.

Benefits of Calculating Net Worth

Calculating net worth provides a variety of benefits. Debby Fowles, author of “The Everything Personal Finance in Your 20s & 30s Book,” recommends calculating net worth in order to set financial goals. Upon setting goals, Fowles recommends calculating net worth at regular intervals in the future in order to monitor the progress of those goals. Net worth also gives individuals and organizations an idea of how the financial community views them and, by extension, the likelihood of successfully securing loans, mortgages or investment capital. Companies calculate net worth for similar reasons — monitoring financial success — and to present regular reports to shareholders as a transparency measure. Governments use such calculations to determine national debt levels.