Once you know how to calculate net worth, you can use that knowledge to make short-term financial plans and establish long-term goals so that you can support yourself years, and even decades, into the future.
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Net Worth Calculation
To determine your net worth, you'll need to take inventory of everything that you own (your "assets") as well as everything that you owe (your "liabilities"). The net worth calculation is your assets net of (or minus) your liabilities.
Net Worth = Assets – Liabilities
Assets are all tangible and intangible items that you own that have value or will have value in the future. This includes:
- Homes and property
- Business interests
Liabilities are any financial obligations that you owe to someone else, such as:
- A person
- A business
- A trust
- The government
- Other entities
Some common liabilities are personal loans, such as a mortgage or car loan. But liabilities may also be outstanding bills, alimony payments, or business debts for which you are personally liable.
- If your assets exceed your liabilities, you will have a positive net worth.
- If your liabilities exceed your assets, you will have a negative net worth.
Here is a list of some common assets and liabilities you might need to consider when calculating your net worth:
Valuing Assets and Liabilities
On its face, the net worth calculation is straightforward, but determining these inputs may take some effort. You must determine the value of each individual asset and each liability.
Assigning a value to some assets and liabilities will be simple. The cash you own and your outstanding bills have values already assigned to them. But other assets and liabilities will require a bit more work to determine their value.
When calculating your net worth, you'll need to determine the fair market value of your assets and liabilities. The simplest way to think about fair market value is to ask yourself what your assets would be worth if you tried to sell them today, or — in the case of liabilities — how much you would have to pay to eliminate your debt.
These amounts can be determined using a few different methods:
- If your stocks and bonds are sold on a public exchange, the fair market value is their trading value on that given day.
- The value of your loans is the amount of principal you owe plus any interest that has accumulated.
- The value of assets such as homes and vehicles can generally be based on sales of similar property in your area.
- Antique jewelry or art may need to be appraised by an expert to determine its fair market value.
The type of asset that is the most difficult to value is a business that you own. If you own a sole proprietorship or are in a partnership, your business interests may hold value. Here are three of the most common methods for determining the market value of a business:
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1. Market Approach
Determine the value of your business by looking at the sales prices of similar businesses in your market. The market approach works best when business sales are made public. Businesses in private markets or niche markets tend not to use the market approach.
2. Cost Approach
Determine the value of your business by calculating the costs it would take to replace or rebuild your business from the ground up. This method tends to be used most often in asset-heavy industries, such as real estate investment.
3. Discounted Cash Flow Method
Base the value of your business on the values of its future cash flows. Once future cash flows are determined, they are then discounted (or reduced) to determine the value of those cash flows in today's dollars. This method is often used in businesses that are well-established, with a long financial history.
Using the Net Worth Calculation
Calculating your net worth can be eye-opening. If you see that your debt balances are high, you can pay down those debts. If you see that your investments are lacking, you can plan to deposit more of your earnings into your savings or retirement accounts.
Tracking and monitoring changes to your net worth can also help you see your net worth increase over time. Not only can a positive net worth support you in retirement, but it also ensures that you have something to leave your loved ones once you're gone.
Wealth transfers are one option for sharing your assets with heirs. You can transfer a certain dollar amount of wealth to other people, either at death or during your lifetime, often without paying gift or estates taxes.
- The lifetime gift/estate tax exclusion (which is sometimes referred to as the Unified Credit) is $11.58 million for 2020 and $11.7 million for 2021.
- Only lifetime wealth transfers that exceed these thresholds will be taxed.
Net worth calculations can also be useful if you want to start a business or need to acquire funding for an existing business. If you approach a bank or other lender for a business loan, they may request your personal financial statement (PFS).
- A PFS is a document typically prepared by a CPA that outlines your financial position at a certain point in time.
- PFS calculations require a few additional data points not included in a net worth calculation, but your net worth will be a great starting point.
When you know how to calculate net worth, you can take charge of your own wealth and make even better financial decisions.
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