What do the bars and lines mean?
What do people mean when they talk about net worth or net equity. Let me explain.
The first of the bars is your Total Assets. These are (in non-technical accounting speak) the things your business owns. This includes the cars, the buildings (if you own one at all), the furniture and other equipment – these physical assets are fairly easy to understand. It also includes the money you have in the bank – just because it’s somewhere else doesn’t mean it’s not yours. Also included are some less obvious things like your Receivables – the money your customers owe you. This makes sense because it’s something that (barring unusual circumstances) will soon be converted to money. You’ll find the details of these on a Balance Sheet report.
The second bar is the Total Liabilities. These are the things that you owe to other people or organisations. Typically, it will include credit cards, bank loans, equipment finance and your Trade Creditors – what you owe your suppliers. Some of the less obvious liabilities are the ones associated with taxes and payroll. When you sell something to a customer, in many countries, part of the price includes tax (GST, VAT) that you then owe to the government. Your accounting system will allocate that to the right liability account for you. Similarly, when you pay your team, you deduct tax from their gross wages, you have other expenses like superannuation and these are all liabilities – things that you have an obligation to pay in the future. Again, check your Balance Sheet for the details if you want to know more.
Now for the fun part. The line on the chart represents your Net Equity. Simply, this is the difference between your Total Assets and Total Liabilities and it essentially represents your stake in the business. The chart starts at the beginning of your financial year, showing the actual result for each month for past months and then the budget for future months. You want to see this line trending upwards – it’s influenced mainly by your profitability. More profit gives you more equity. If you’re a sole trader, what you take out in Drawings will reduce your equity.
Is Net Worth what the business is worth?
Calculating your Net Worth isn’t a business valuation. The Total Assets, Total Liabilities and Net Equity will probably be part of the discussion if you were valuing the business but they wouldn’t be the whole of the story. They do tell a prospective buyer something about the success of your business, but not everything.
There’s much more to consider for a valuation, such as the goodwill of your business, but that’s a story for another day.