Understanding financial statements-II

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What is 'net worth'?

Net worth is defined as the value of an organisation when its liabilities have been deducted from the value of its assets. It means the net assets: the excess of value of resources over liabilities to creditors. The net worth is the outcome of an arithmetical formula called 'accounting equation' assets minus liabilities equals net worth or A - L = NW.

The difference between your assets and your liabilities represents your net worth. Thus, net worth is the difference between the total assets of an entity and its external liabilities - it represents what it owes to its owners. The terms net worth, owner's investment or capital all has the same meaning in accounting. The accounting equation can be written in a different way: liabilities plus net worth equals assets (L + NW = A).

A balance sheet is a statement of what company 'owes' and what it 'owns'. Yes, that precisely is what a balance sheet is about! We already have seen that a balance sheet of a company is a financial statement of assets and liabilities of the company, containing what the company owns and what it owes at a particular point of time.

The various sums of money that it owes are called 'liabilities' and the things that the company owns are called 'assets'. At any point of time, and so at the last day of the financial year, what the company owns matches with what it owes plus its net worth!

This is obviously so because what a company owns cannot be more or less than what it owes and its net worth and vice-a-versa. Hence the term 'balance sheet' indicates the fact that the total of liabilities always balances (or equals) the total of assets. Put differently, assets and liabilities plus net worth offset each other.

Therefore, the totals of the two pairs of any balance sheet are always equal and the difference between the totals of assets and liabilities is made up by the net worth (in a company balance sheet this is called 'shareholders' funds'.)

A statement of 'what you own and what you owe'