The net worth of a business is the total dollar value of its assets, minus its debt obligations. A company is said to have a positive net worth when the value of its assets outweighs that of its liabilities. The calculation is considered negative when liabilities exceed the assets’ value.
While this calculation is generally adequate for most purposes involving individuals, there is often a necessity to go a step further to determine the tangible net worth of a business. We will explain the difference below, as well as why investors should pay attention to tangible net worth.
Rather than calculating the value of all the assets of a business, one must exclude the value of its intangible assets such as intellectual property, copyrights, patents, and trademarks and the like. In other words, only assets readily convertible into cash (liquid assets) are considered tangible.
These assets come into play when trying to establish the valuation of a company, convert assets into cash to obtain working capital, or liquidate the organization. Simply stated, a company’s tangible net worth is the valuation of all the physical assets of a company, less its outstanding financial obligations.
For businesses, these assets can include:
• Cash on hand
• Accounts receivables/money owed to the company
• Equipment such as vehicles, production machinery and computers
• Office facilities and buildings
• Real estate holdings
For individuals, these can include:
• Home equity
• Personal real estate holdings
• Checking, savings and investment accounts
• Boats, motorcycles, RVs and automobiles
• Fine jewelry
Tangible net worth can also come into play for an individual who is trying to get a personal loan or is seeking financing for a small business. In addition to offering a more accurate assessment of a financial position, tangible net worth also serves as an indicator of the total value of the collateral available to a lender should a need to call in a loan arise.
The data needed to calculate the tangible net worth of a business can be found on its balance sheet. Total assets, total liabilities and intangible assets should all be listed there.
The equation functions as follows:
TNW = Total Assets – Liabilities – Intangible Assets
Subtracting total liabilities from total assets will return the basic net worth of the organization. Subtracting the valuation of intangible assets from that result will identify the company’s tangible net worth. This equation can be applied to individuals as well.
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Determining the tangible net worth of a company reveals its physical net worth, without the complications of placing valuations on intangible items. The assumptions and estimations required to undertake that endeavor can be too imprecise to reveal the true valuation of a company.
In turn, determining a company’s tangible net worth reveals its ability to fulfill its financial obligations. Again, having a solid grasp of the tangible net worth of an entity provides an indication of the amount of collateral available should the company have to be liquidated. In fact, some lending agreements specifically state that a borrower must maintain a certain tangible net worth during the term of the loan, lest it be considered in default.
This can be a factor for individuals as well. For example, many mortgage lenders require borrowers to have a certain amount of cash on hand to qualify for the loan.
A high tangible net worth endows an organization with lots of options, thanks to the ready liquidity it has at its disposal. It also helps reassure potential investors. After all, the security of a company is, in part, defined by its cash position. This is one of the reasons investors should pay attention to the tangible net worth of a company in which they are considering investing. That said, companies need more than cash to prosper. Tangible assets, while certainly valuable, do little to differentiate a company from its competitors.
Intangible assets are typically where a company’s unique market position can be found. Its intellectual properties, patents, trademarks, and reputation are what ultimately attract customers. Further, certain intangible assets can potentially make attracting new customers less costly. For example, a well-known and respected brand name, marketplace goodwill, innovative ideas and the like are what can potentially set a company apart and provide it with a competitive advantage.
This, of course, assumes the company has the wherewithal to bring those assets to bear. Lacking an effective strategy to take advantage of those benefits is essentially the same as not having them at all.
Both shareholder equity and tangible net worth are measures of the company’s intrinsic value. However, net tangible assets are more of a theoretical valuation, while shareholder equity measures the actual value at which a company is financed as a result of investor activity. Both are listed on a company’s balance sheet, however, shareholder equity takes intangible assets into consideration, sometimes to the detriment of investors.
During the dotcom boom of the early 21st century, investors were pouring capital into any business idea with a .com domain name. The goodwill afforded these companies far exceeded their ability to perform, resulting in excessive speculation and wildly exaggerated market values.
For example, a share of the search engine provider’s Ask Jeeves, Inc. (NASDAQ: ASKJ) common stock sold for $180 in late 1999. This represented nearly 200 times the stockholder’s equity and resulted in an indicated market value of $4 billion, even though its balance sheet only showed assets of $32 million.
After the dotcom crash, Ask Jeeves, Inc. was valued at a more realistic $50 million, and its common shares were valued at $1 (yes, one dollar) each, demonstrating quite vividly that its intangible assets had been enormously over-valued. While something of an extreme example, this illustrates how getting the value of intangible assets wrong can potentially have an adverse effect on an investment.
The example above also demonstrates the importance of portfolio diversification; ideally incorporating non-market correlated alternative investments. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split of stocks, bonds, and alternatives, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification.
These assets were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. Yieldstreet was founded with the goal of dramatically improving access to these alternative assets by making them available to a wider range of investors.
The resulting diversification can potentially protect a portfolio of assets during periods of extreme volatility, thus helping to preserve an investor’s hard-won net worth.
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