There is one advantage to being dull and thick-headed like me. My disability forces me to learn advanced financial subjects in very simple terms. Now let's tackle the concept of Net Worth in laymen's language (baby language).
So mean.
In simple terms, your Net Worth is the cash you would hold if you sold off - you liquidated - everything that you owned and paid off all of your debt.
For a great many Americans, that number is a negative number; i.e., they owe more than what all of their assets combined are worth. Obviously, banks don't rush to make loans to people with a negative net worth.
Here's a good rule of thumb. Banks will seldom make a loan larger than a borrower's net worth. If your borrower has a $500,000 net worth, the largest bank loan for which he might qualify is usually less than $500,000.
Residential mortgage loans are an exception to this rule. First mortgages on homes, where the borrower has demonstrated the ability to afford the payments (think of a physician just two years out of medical school with no assets but an increasing salary) are very desirable assets for banks. These residential mortgages are very liquid assets; i.e., they can be quickly be sold off to another bank for cash.
As the owner of C-Loans.com, the commercial mortgage portal, I often hear mortgage brokers grumbling, "C-Loans doesn't work. I submitted my $3 million commercial loan to 18 banks, and not one of them responded."
When I look up their deal, almost invariably their borrower - the one trying to borrow $3 million - has a net worth of just $250,000. Hellooo? To successfully borrow $3 million from a bank, you need a net worth of at least $3 million.
If you hooked my precious parts up to electrodes
and asked me, "Is this a good investment?"
I would passionately answer, "Oh Heavens, Yes!"
Do this! Learn the profession!
I used a fancy finance term earlier - liquidate. To liquidate an asset means to convert it to cash, the most liquid of all assets.
When banks seize the assets of a delinquent borrower and liquidate them, it means they sell off the assets to some used furniture broker or used car dealer. You never want a bank to liquidate your assets. They sell off your assets in a hurry for pennies on the dollar. Your new Play Station 5, for which you just paid $500, might fetch a lousy $55; and that $55 must be used to pay down your impossible debt.
Let's get back to net worth. How does a banker know your net worth? He makes you complete a financial statement. A Financial Statement consists of two documents - a Balance Sheet and a Profit and Loss Statement.
I belly-laugh every time I read the above meme.
How many times have you said, "This lender is an idiot."
Your net worth appears at the bottom of your Balance Sheet. Your Balance Sheet starts with your Liquid Assets - like cash, marketable securities (stocks), bonds, and the cash value of your life insurance policy. Added to that are your Fixed Assets - like your house, your real estate, your cars, your company, your 401k, and your profit sharing plan.
Combined your Liquid Assets and your Fixed Assets give you your Total Assets.
On the right side of the Balance Sheet are your Liabilities.
Oh, Heavens, if my wife sees this...
STOP!
Remember, we are trying to determine your Net Worth - the value of your Total Assets minus all of your debts.
Okay, now back to the right side of your Balance Sheet, where all of your debts are listed. We have your Personal Loans, your Credit Cards, your Auto Loans, and finally your Mortgages.
How about a first aid kit for his cut feet?
Combined, we have your Total Liabilities. When we subtract your Total Liabilities from your Net Assets, we have -
1. Your Current Ratio
2. Your Quick Ratio
3. Your Net Worth; or
4. Your Liquidation Value
Cue the Jeopardy tune...
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Right Answer: Your Net Worth