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The Net Equity Value Equation
Net Equity Value = (enterprise value + cash and cash equivalents + short and long term investments) – (short term debt + long term debt + minority interests).
Why Net Equity Value is Important to Small Businesses
Banks use net equity value to determine the financial health of a company. When determining whether or not to underwrite a business loan, most banks will first analyze the this equation or equity value. Because this measurement weighs a business’s current assets against its current liabilities, net equity value offers an analysis of how much the business is worth as collateral for a loan.
Many business owners mistakenly believe it’s okay to show net losses on the business’s tax return each year. Intentionally doing so may contribute to a long-term problem when it’s time to obtain business capital, or to increase the company’s working capital line of credit. Bank lenders track the Net Equity for the business applicant over time going back as far as five or even ten years. The bank loan underwriter looks for at this long-term trend and finds it favorable when there is increasing Net Equity over time. When that’s not the case, especially if the trend is declining Net Equity, obtaining bank capital is very difficult.
Net Equity vs. Net Assets
Although similar, net equity and net assets differ in one important way. Net assets are defined as total assets minus total liabilities – where inventory is included in the company’s assets. Conversely, the net equity value calculation does not include inventory as a part of the business’s assets. Fluctuating inventory will affect a company’s net assets day-to-day, but will not affect the net equity value in the same manner.