Tangible net worth can be defined as the total net worth of a company, excluding any value derived from intangible assets like copyrights, patents, and intellectual property. It can be easily obtained by subtracting the company's total liabilities from the tangible assets.
The tangible net worth comes into play when money lenders and investors want to look upon the company's credibility. A balance sheet portrays both liabilities and assets of a company. Among them, the value earned from tangible assets. The tangible assets of a company include the following:
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The following formula is used to obtain the tangible net worth of a company:
Tangible net worth = Total assets - total liabilities - intangible assets
For example, let us assume that a company XYZ reports total asset value as AU$200 million in the year 2020 in their balance sheet. On the other hand, the value of total liabilities is AU$80 million, and the value of intangible assets is AU$35 million in the same year. Therefore, according to the formula of tangible net worth:
Tangible net worth = AU$(200-80-35) million = AU$85 million.
Therefore, the tangible net worth of the company XYZ in the year 2020 is AU$ 85 million.
Debt covenants are promises or agreements made by the borrower to follow the agreed-upon terms during the loan agreement discussion. In exchange for a loan, the borrowing party undertakes to abide by specific benchmarks. They're also known as "bond covenants" informally.
Tangible net worth is an essential parameter for companies when it comes to debt covenant. It is accessible to the moneylender or the investor as it assures the company's credibility and determines the worth of the physical assets that the company owns without taking estimation and approximation value involved with intangible assets.
Tangible net worth also helps the lender understand the borrowing company's capability when it comes to repaying the debt. Some moneylenders even utilise tangible net worth as an eligibility criterion for companies to lend money. In those cases, a certain level of tangible net worth must be maintained by a company to get financial support from money lenders.
The purpose of tangible net worth is to obtain the valuation of physical assets owned by a company without including the value of its liabilities as per the recordings in the balance sheet. It can also be said that tangible net worth represents the company's liquid assets that can be utilised during the state of bankruptcy.
The tangible net worth is one of the easiest methods to obtain the net value of physical assets that are owned by a company than evaluating the valuation of intangible assets such as customer goodwill or intellectual properties.
Tangible net worth comes with a bunch of pros and cons. So let us first discuss the pros of tangible net worth.
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The following are the cons of tangible net worth:
Let us understand the concept of tangible net worth with the help of an example. If a company XYZ is willing to take financial support from a moneylender for carrying out its business operations. The tangible net worth signifies the total valuation of a company's liquid assets and is, therefore, acts as collateral when the company applies for a loan. For example, suppose the XYZ company owns AU$12 million tangible net worth. The moneylender here would look upon the value of total tangible net worth to determine the company's credibility and predict its capability to repay the debt.