Can My Business Have a Negative Net Worth?
Setting Up a New Business
Open My Own Business
By Jared Lewis
What Debt Ratio Is Good for Businesses?
How to Analyze the Key Ratios of Corporate Finance
What Financial Management Problem Could a Quick Ratio Identify?
How to Calculate the Cost of a Debt
Why Do Companies Want to Keep Debt Off of Balance Sheets?
The net worth of a business is a key consideration for many investors. The financial stability of a company is usually a prerequisite for investors to decide to invest in the company in the first place. Only investors who live on the edge and bank on the rebound of a company consider sinking their money into a company that shows signs for financial melt down. Companies with a negative net worth are not typically the object of most investors' money.
Calculating the net worth of your business is fairly simple to do. Net worth is expressed as an outcome of subtracting your total liabilities from your total assets. In other words, you add up the value of all assets, which generally include cash and other equity. You then add up all your debt. Subtract that debt from your assets and the resulting number is your net worth.
Negative Net Worth
When a business has more liabilities than assets, it is said to have a negative net worth. However, this negative net worth actually indicates that the business is insolvent or bankrupt. Individuals can have a negative net worth and not necessarily have to declare bankruptcy so long as they can service their debt in installments. The same is true of a business, but generally businesses that are insolvent do not tend to last much beyond the point of bankruptcy. Once bankruptcy has been officially declared, business assets are sold off to pay creditors and the business is dissolved.
Another way to assess the financial health of a company is to look at financial ratios. This is done with a closer examination of the balance sheet. Ratios, such as the debt-to-equity ratio, are one of the simplest ways to examine a company's financial well being, although it should not be considered the only means of doing so. A company with $500,000 in debt, but $1 million in assets has a debt-to-equity ratio of 0.5. However, a company in the opposition position with $1 million in debt and only $500,000 in assets would be staring down a 2.0 debt-to-equity ratio. Generally speaking, ratios over 1.0 are considered high or risky by many investors and should be avoided if possible. The closer to 2.0 a company goes, the riskier it becomes as an investment.
One potential problem that you may run into when valuating your business is in deciding which figures to use when determining the value of your assets. Two basic approaches exist in regard to this process. The market-based approach values assets based on their current market value. The cost-based approach bases their value on what you paid for them initially. The cost approach has its limits when it comes to selling a company, but it can give a fairly accurate picture with regard to a company's solvency.
Bloomberg: Avoid Negative-Net-Worth Stocks Like the Plague
Fox Business: Do You Know Your Net Worth?
Iowa State University: Understanding Net Worth
Jared Lewis is a professor of history, philosophy and the humanities. He has taught various courses in these fields since 2001. A former licensed financial adviser, he now works as a writer and has published numerous articles on education and business. He holds a bachelor's degree in history, a master's degree in theology and has completed doctoral work in American history.
Difference Between Insolvency & Negative Equity
How to Calculate Sufficient Liquidity
How to Determine the Total Value of a Corporation
What Are the Disadvantages of a High Debt-to-Equity Ratio?
Common Stock Issuance & Its Effects on Debt-to-Equity Ratios
Financial Ratios Used by Investors
The Fixed Asset-To-Equity Capital Ratio
Is Low or High Better on Financial Ratios?
How to Set Up Collateral
1 Difference Between Insolvency & Negative Equity
2 How to Calculate Sufficient Liquidity
3 How to Determine the Total Value of a Corporation
4 What Are the Disadvantages of a High Debt-to-Equity Ratio?