What is Effective Net Worth?
In finance, effective net worth is a company’s shareholders’ equity, the amount that would be returned to stockholders if all of a company’s assets were liquidated and all its debts repaid, plus subordinated debt, unsecured loans or bonds that rank lowest with respect to claims on assets or earnings.
Adding subordinated debt, in effect, increases a company’s net worth and is used by senior creditors to determine a company’s ability to pay them back, should they loan it money.
How to Calculate Effective Net Worth?
The formula for effective net worth is as follows:
Effective Net Worth = Total Assets – (Total Liabilities + Subordinated Debt)
Effective net worth differs from actual net worth, which excludes subordinated debt. Effective net worth considers the total amount of debt a company has and its interest payments as well as whether or not any debts are overdue. It is important for lenders because it determines their chances of getting paid back.
How Effective Tangible Net Worth Works
A company’s effective net worth is the total amount of money it could use to pay off its debts if necessary, which is a stronger indicator of financial health than net worth. This figure is useful for companies that are heavily in debt but still have the means to pay off their outstanding balances.
Benefits of Effective Net Worth
Effective net worth is a measure of your financial health. It’s an important piece of information that can help you determine what you can afford in the present and whether you’re on track to meet your goals for the future.
Effective net worth can also help you keep better track of your assets and liabilities and make the process of budgeting easier since it provides a more accurate picture of the money that is actually available to spend.