Net worth and equity are two words we hear a lot in business and finance. When we hear people talking about these terms, it might sound like they’re talking about the same thing because they use them interchangeably when in reality net worth and equity aren’t the same.
There is a difference between net worth and equity; understanding that difference paints a clearer picture of an entity. If you own a business you need to know the difference between equity and net worth.
The difference between net worth and equity is simple at the basic level, but there are nuances that may be confusing to you. Let’s discuss the difference.
What is Net Worth?
Net worth = total assets – total liabilities owned by a company or an individual. It is a measure of your financial health. They include both things you own outright, such as your house and things that are partially owned, such as stocks and bonds.
Net worth is the amount of money you have leftover after subtracting the amount of debt you owe. To see how this works, imagine that you own a house worth $100,000. In addition, you have $20,000 worth of debt on it, so you owe $80,000.
Now suppose you sell the house for $120,000. You make a profit of $20,000, and your net worth is now $80,000. On the other hand, suppose you didn’t sell the house. Instead, you paid the $20,000 bill, but you kept the $80,000 house. In this case, your net worth is now $100,000, but you don’t have any debt. But in reality, very few people are able to pay off their mortgages or their debts by selling assets they own.
Instead, people borrow money and take out new loans to pay off their old ones. This increase in debt is called leverage. Too much debt means that you are overleveraged, and you may have to sell assets that are worth less than the amount you owe.
What is Equity?
Equity is the value of a business or an investment. The equity of a business is the asset value of a business minus its debts.
The equity of an investment is the sum of its value, minus its liabilities or debts.
Equity = Net Worth + retained earnings
Assets = Net Worth + retained earnings
Liabilities = Net Worth – retained earnings
Net Worth = (capital + cash + other assets) – (liabilities + commitments)
Conclusion
Don’t get confused with net worth vs equity. It’s actually quite straightforward if you know the difference between the two.
Related: How to Calculate Net Worth