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In financial terms, an asset is anything owned by a person, company or other entity which has a monetary value, and can be converted to cash. Liabilities are any debts or claims which the person or organization is legally required to pay. Net asset value (NAV) is the value left when liabilities are subtracted from assets. If the value is positive, the party is considered solvent; if the value is negative, then the party is considered insolvent.
Net asset value is most commonly associated with mutual funds. The formula for figuring this is:
This is calculated at the end of business each day and is referred to as the net asset value per share. The NAV of a mutual fund can vary daily as a result of market fluctuations which affect the fund’s investments.
Calculating liabilities for a corporation can be a bit more complicated than for an individual. In addition to loans, mortgages and operating debt, a company must include any deferred stock dividends and unpaid taxes which will be due within one year. Withholding tax, unemployment tax, real estate tax and personal property taxes all need to be considered.
A company’s NAV, also known as book value or shareholder’s value, does not necessarily equate to a viable sales price. NAV only considers tangible assets, not intangibles, such as goodwill, which help determine its future earnings potential. If a company holds a patent that promises to significantly increase revenues, this would justify a sales price that is higher than book value. Conversely, if market demand for the company’s product line is decreasing, then the company would probably sell for less than its NAV.
Net worth calculations are also important for nonprofit organizations. While charities do not exist to make a profit, a positive net asset value is necessary if the organization plans on growing. Foundations and other large donors often review the balance sheets and budgets of charities prior to making any grants or donations. They do this to ascertain if the organization will remain solvent and capable of fulfilling its charitable purpose.
While NAV is not normally applied to rental real estate properties, it is used by many analysts to evaluate shares in real estate investment trusts (REITs). These are public companies which sell common stock to investors. Their primary business is buying and managing income-producing real estate, such as hotels, apartment buildings, shopping centers and office complexes. The profits are distributed to the stock owners in the form of dividends. In order to determine a more accurate evaluation, calculations for the NAV of an REIT use the current market value of the properties, instead of the depreciated basis.
In figuring out your NAV, you should consider all of your assets. This includes cash, retirement savings, redemption value of life insurance policies, current value of stocks or bonds, plus the fair market value of all personal and real property owned. The liabilities include any mortgages, debts or legal claims for which he is liable. Since this formula does not take into account his income and ability to pay the debt, a negative net asset value is not an indication that he should declare insolvency. It is, however, a necessary benchmark for financial planning purposes.
Can a company buy property for more than the net asset value?