Financial Glossary
Net Worth
Net worth is the accounting measure of the residual interest in an entity's assets after all liabilities have been deducted: Net Worth = Total Assets - Total Liabilities. For individuals, it represents personal financial wealth; for businesses, it is synonymous with shareholders' equity or owners' equity and appears as the bottom section of the balance sheet. Net worth grows when a business retains earnings or when owners contribute additional capital, and it shrinks when the business incurs losses or makes distributions. Lenders and investors use net worth as one indicator of financial stability and as a floor for covenant calculations, though it reflects book values rather than market values of assets.
Problem & Application
A self-storage facility owner has a balance sheet showing total assets of $4.2 million (the property at depreciated book value, plus receivables and cash) and total liabilities of $2.9 million (mortgage and accounts payable). Net worth is $1.3 million. The owner's lender requires a minimum net worth covenant of $1 million as a condition of the loan. After a year of strong profitability, net income of $220,000 is retained rather than fully distributed, increasing net worth to $1.52 million and providing comfortable headroom against the covenant. If instead the owner had distributed all earnings as dividends, net worth would remain at $1.3 million -- still compliant but with less buffer. Monitoring net worth against covenant thresholds is a routine part of any loan-compliance review.
In Short
Net worth provides a snapshot of financial strength, helping businesses and individuals assess their overall financial position and make strategic decisions.