The term net assets refers to the value of a company’s assets once the value of its liabilities has been deducted. Net assets are also referred to as book value or shareholders’ equity.
Example of net assets
The basic formula for calculating a company’s net asset value (NAV) is:
Total Assets - Total Liabilities = Net Asset Value (NAV)
In some cases, it can be useful to fine-tune this. For example, investors might be interested in a company’s net current assets or net fixed assets. It’s usually possible to do this as companies generally break out their assets and liabilities on their balance sheets.
Understanding assets and liabilities
In accounting, an asset is something that has monetary value. Sometimes, this monetary value is intrinsic to the asset. For example, the value of a cash deposit is exactly what’s shown in the bank account. At other times, a fair value may need to be assigned to the asset.
Valuing assets fairly is one of the most important jobs in accounting. Both overstating and understating the value of assets can give a misleading impression of a company’s financial position.
Liabilities are obligations that must be met out of the company’s financial resources. Most liabilities are essentially debts even if they are not explicitly described that way. This means that they have an intrinsic value although this may fluctuate if they are on a variable interest rate.
Net asset value (NAV) and bad debt provision
If a company uses accrual accounting and offers credit, it may need to make provision for bad debts. To do this, a company can enter a bad debt expense line on its profit and loss statement and a corresponding line in the assets section of its balance sheet.
Generally, the bad debt expense lines go in the selling, general and administrative expenses section of the profit and loss statement and directly below, the accounts receivable section on the balance sheet. Bad debt provision is technically known as a contra asset as it reduces the value of an asset.
If the debt does have to be written off, the amount of the write-off is deducted from the accounts receivable line in the profit and loss statement. The same amount is deducted from the bad debt provision line in the asset section of the balance sheet and transferred to the liabilities section of the balance sheet.
Technically, bad debt provision does not affect a company’s net asset value (NAV). This is because the provision is counted as an asset until (and unless) the debt needs to be written off. In practical terms, however, investors may take it into consideration when calculating a company’s real-world net asset value (NAV).
Net asset value (NAV) and assets with variable value
There are two reasons why an asset would have a variable value. The first is simply because the nature of the asset is such that its value fluctuates over time. For example, each share in a company may have the same value. The value of these shares may, however, vary depending on how the company’s performance is perceived by the stock market.
The second is because an asset is expected to decline in value over time. This process is known as depreciation (for tangible assets) and amortization (for intangible assets).
In the first instance, companies simply have to value the assets as fairly as they can when they create their financial statements. In the second instance, there is usually an accepted formula for calculating the amount by which an asset will decline in value.
Once the anticipated decline in value has been calculated, it can be shown on a balance sheet as a separate line item in the same way as bad debt provision. For example, if a company lists property on its balance sheet, it may list the depreciation on its property as a contra asset.