Accounting Net Worth Methods
Financial accounting can reveal many significant facts and trends within an organization, which is why regulatory agencies require businesses to produce financial statements and why businesses create and use them internally. Investors also use financial statements, such as balance sheets that show net worth, to make decisions about where to invest and when to sell their holdings. Net worth shows how much a business is worth at a given point in time, but there are multiple methods available for accurately determining net worth.
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Creating Balance Sheets
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The fundamental accounting method for determining net worth involves producing a balance sheet, which is one of the basic types of financial statements. A balance sheet lists all of a business's assets, as well as its liabilities. The sum total of assets, minus all liabilities, equals net worth. Assets include cash, inventory, investments, intangible assets (such as patents and brand name recognition) and plant assets (which includes buildings, land and machinery). Liabilities include items such as debt, employee wages and taxes owed.
Market-Based Method
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The market-based method of net worth determination uses free markets to place value on a business's assets. For example, a business may hold 100,000 shares of its own stock valued at $40 per share, yielding a net market value of $4 million. That is considered part of its net worth. If the business sells the shares, the taxes and fees would be considered liabilities, counting against the net worth.
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Cost Method
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The cost method of determining net worth is the major alternative to the market-based approach. It uses the actual purchase prices that a business pays for its assets as the bases for determining value. The cost method adds in any money the business spends to improve its assets and subtracts money based on depreciation if the assets in question lose value over time, as is the case with machinery and factories.
Complications
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Even with access to both market and cost methods of accounting, a business's accounting team may face challenges determining the value of assets to determine net worth. This is because while some assets are liquid, or easily converted into cash, others are illiquid. Intangible assets, such as brand names, have value because customers recognize them and know what to expect from the products on which they appear, but they have no one-time cost and aren't similar to other assets that investors sell in markets. In these cases, accountants must use other methods to estimate the value of intangible and illiquid assets. Investors who want more complete pictures of what businesses are worth need to examine balance sheets in detail and look for these special cases.
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