Net Worth

Net Worth shows the owners' share of the total resources of the company. In the case of a proprietorship or partnership, the owner's or owners' names are listed along with their respective portion of the company's net worth. For a corporation, the equity [or net worth] section of the Balance Sheet is normally broken down into the following categories:

• Capital stock
  
• Earned surplus
  
• Treasury stock
  

Capital stock represents the total transferable interests of the owners of the corporation. Earned surplus represents the net earnings [the net income] of the business since its inception that has been retained by the company to be plowed backed into its operations rather than paid to shareholders in the form of dividends [or in the case of a partnership or proprietorship payments to the owner or owners in the form of distributions].

As a creditor, you are normally more interested in tangible net worth than a customer's stated net worth - which is the amount listed on the balance sheet in the equity section. Tangible net worth equals stated net worth minus the value of all intangible assets listed on the balance sheet such as goodwill.

Another account found in the equity section of some balance sheets is Treasury Stock. When companies repurchase stock already issued and sold, the repurchased shares are classified as Treasury Stock. These shares may be held by the company indefinitely, or reissued to the public or retired. There are a number of reasons that companies repurchase stock, including these:

• To increase earnings per share by reducing the number of shares outstanding.
  
• To reduce the number of shares with voting rights
  
• To counter a tender offer
  
• To provide shares for the exercise of stock options, warrants and convertible securities
  

Usually a balance sheet is set up in two columns, with assets on the left, and liabilities and net worth on the right hand column.

The sums of the two columns are equal. The total resources of the company (the assets) are "balanced" by the claims of its creditors (the liabilities) plus the claims of the owners (the net worth).

Depending on market conditions, the value of inventory may shrink in value - not from sales of inventory made in the ordinary course of business, but instead based on an accounting rule that states that inventory must be carried on the books of a company at the "lower of cost or market". What this means is that if the cost of inventory using whatever inventory valuation method the company uses [such as last-in- first-out or LIFO] is higher than the fair market value of that inventory, the company must write down the value of its inventory to the lower dollar amount. However the claims of the company's creditors against these assets are not written down at any time. Payment of debts must be made through liquidation [the conversion into cash] of asset of the company.

A company's net worth, therefore, can be thought of as a residual claim on the assets of the company by the company's owners. A company's owners will only receive money in a liquidation if all of the company's liabilities are settled [paid] first.

Source: Michael Dennis, author of "Credit and Collection Handbook" available at the NACM Bookstore.