Financial term of the Week

Understanding net worth

A“net worth” statement or “balance sheet” is designed to provide a picture of the financial soundness of your business at a specific point in time. Net worth statements are often prepared at the beginning and ending of the accounting period, but can be done at any time. The statement records the assets of the business and their value, and the liabilities or financial claims against the business (debts).

The amount by which the value of the assets exceed the liabilities is the net worth (equity) of the business. The net worth reflects the amount of ownership of the business by the owners. The formula for computing net worth is: Assets - Liabilities = Net Worth Likewise, the following formula helps explain the interaction of the elements of the statement.

Assets = Liabilities + Net Worth

Classifications of assets and liabilities

Assets are often divided into three categories: current, intermediate and long term.

In some situations, the intermediate and long-term asset categories are combined into one group called “fixed assets”.

Current assets consist of cash and near cash assets. Current assets often contain assets that will be sold and converted to cash during the upcoming accounting period. Crops and livestock held for sale are typical current assets for a farm business. Intermediate assets have a useful life of more than one year. Typical farm intermediate assets are machinery, equipment and breeding livestock. Long-term assets include real estate such as land, buildings and facilities. These are assets commonly referred to as real estate.

Liabilities are usually classified the same way assets are grouped. Current liabilities consist of payments that are due during the upcoming accounting period. They include accounts payable and interest and loan payments due during the accounting period.

Intermediate liabilities consist of outstanding debt against intermediate assets and often have a term of three to seven years. Interest and principal payments due within the coming year are included in current liabilities.

Only the amount of debt remaining after the current year’s principal payment is deducted is included in intermediate liabilities.

Long-term liabilities consist of outstanding debt against long-term assets and may have a term of 20 or more years. Interest and principal payments due within the coming year on this debt are included in current liabilities.