A company prepares a financial statement at the end of the financial year which depicts a company’s total assets, debt and shareholders’ equity that eventually provides the financial stability of that company. When a company’s financial statement is examined, it is important to recognise the shareholder’s equity or net worth. The shareholder’s equity or net worth of a company equals the total assets minus the total liabilities. If the company does well, its profits increases and its net worth increases too. This article deals with the concept of net worth and its impact on the creditworthiness of the company.
NET WORTH OF A COMPANY
Section 2(57) of the Companies Act, 2013 defines net worth as the aggregate value of the paid-up share capital and all the reserves created out of the profits after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off, as per the audited balance sheets but does not included reserve created out of revaluation of assets, write-back of depreciation and amalgamation. The net worth of the company’s examined by a company’s financial statement. A signed copy of every financial statement, including consolidated financial statement, if any, is to be issued, circulated or published along with a copy of any notes annexed or forming part of such financial statement, the auditor’s report and the Board’s report.
For any contravention the company becomes punishable with fine of not less than Rs 50,000 and extending to Rs 25,00,000. Every defaulting officer is punishable with imprisonment extending to three years or fine of not less than Rs 50,000 extending to Rs 5,00,000 or both.
This provision is deliberately enacted to protect the shareholders and the general public and they impose a definite duty upon the directors. It is necessary that these duties should be properly carried out and also when the directors fail to carry out their duties the penalties as provided in the Act must be imposed.
Financial Statement also known as the net worth statements shows company’s worth. The financial statement in relation to a company has to include the following-
- The balance sheet as at the end of the financial year,
- Profit and loss account or in the case of a company carrying on any activity not for profit an income and expenditure account for the financial year.
- Cash flow statement for the financial year
- A statement of changes in equity if applicable
- Any explanatory note annexed to, or forming part of the balance sheet or statement of changes
Provided that the cash flow statement must not be included in the financial statement of one person company, small company and dormant company.
A copy of the financial statement as adopted by the company in general meeting has to be filed with the Registrar within 30 days of the Annual General Meeting in accordance with the prescribed manner. In case of one person company, a statement that is adopted by its members has to be filed within 180 days from the closure of the financial year. In case of one or more foreign subsidiaries which have not established a place of business in India, accounts of such companies have also to be attached to the financial statements. Where an Annual General Meeting could not be held the documents would have to be filed with the Registrar in the same manner as if the meeting was held but the reason must be explained as to why the meeting could not be held.
CALCULATION OF NET WORTH
The net worth of a company is calculated by deducting liabilities from the assets. Assets of a company are the items that a company owns and that which could provide a monetary benefit in future. Liabilities on the other hand are the legal debts a company owes to a third party.
Net worth = Assets – Liabilities
The proper balance of liabilities and assets provides a stable foundation for the company. While calculating if it is seen that the assets are more than the liabilities i.e., a positive answer is received then it can be said that the company has a healthy financial condition but in case the liabilities exceed the assets, the company is under debts and is suffering losses.
Companies like Reliance Industries Ltd, Tata Consultancy Services, HDFC Bank etc have a high-net-worth reason being their high value of assets, smart investments, lower debts and by lowering unnecessary expenses.
Reliance Industries Ltd had a net worth of over 6.4 trillion Indian rupees in financial year 2022. The net worth of Tata Consultancy Services is 13.80 lakh crore Indian rupees which is much more than the Reliance Industries Ltd as its total assets are worth Rs 89, 139 crores.
WHY IS NET WORTH OF A COMPANY IMPORTANT?
The net worth of a company is important in order to keep a track of the financial stability. Net worth represents the total value of the company. It helps to make a future investment plan and helps to set a financial strength and indicates whether the company is in a position to do capital expenditure or not. Net worth of a company also indicates the company’s creditworthiness. Investors and shareholders calculate the return on net worth to get an idea of company’s worth and whether it will be profitable to invest in that particular company. The more the net worth, the more the shareholders would want to invest in the shares of company thereby increasing share capital of the company. Low net worth depicts low creditworthiness which means it is not in a position to raise funds from the market in order to increase the efficiency of the business. In order to improve the return company should pay off its debts and decrease its miscellaneous expenditure.
FACTORS DETERMINIG THE NET WORTH OF THE COMPANY
- EBITDA Size-
The calculation of a company’s value based on earnings before interest, tax, depreciation and amortization functions act as a stand- in for the company’s enterprise value. This value eliminates the non- operating effects unique to each business and measures its financial performance.
- Industry Demand-
The industry in which a company operates will be extremely important in determining valuation. If a company operates in a hot industry, it is likely that it will be able to achieve a higher valuation compared to another company in a different industry at the same stage of development and current transaction.
- Market Size-
The larger the market in which a company operates, the bigger the potential upside of an investment. Therefore, the bigger the market, the bigger the potential valuation of a company can command and vice versa. Investors get a glimpse of the business’s value by assessing the company’s earning capacity based on market demand.
- General Economy-
Where the economy is performing badly (i.e., during a recession) it is likely that there will be less appetite to be invested in a high-risk asset class such as early-stage companies. Consequently, it is likely valuations during these periods will be lower than when the broader economy is performing well.
The net worth of a company gives an overview of the company’s financial condition and also helps the investors, shareholders, stakeholders, etc to look into the working of the company. The financial statement depicts the assets and liabilities with which the company can determine its position in the market and can anticipate risks and work accordingly. It gives a SWOT analysis of the company thereby it can be assumed if the company will flourish in the upcoming years or not. Various companies in India have flourishes in the past decade. Even during the pandemic companies like, Reliance, Tata etc did not lose its existence because they had anticipated the financial condition of the company and worked accordingly which makes them the highest contributor of GDP of the country.
- The Companies Act, 2013, No. 18, Acts of Parliament, 2013 (India).
- ECONOMIC TIMES, Tata Consultancy Services Balance Sheets, Financial Statements – The Economic Times (indiatimes.com)
- AVTAR SINGH, COMPANY LAW 428 (Eastern Book Company 2018).
- TIMES OF INDIA, https://timesofindia.indiatimes.com/blogs/voices/factors-affecting-the-valuation-of-your-online-business/
- Camelia Burja, Factors Influencing The Companies’ Profitability, 215,file:///C:/Users/shrut/Downloads/Factors_Influencing_The_Companies_Profitability.pdf.
 The Companies Act, 2013, § 2(57), No. 18, Acts of Parliament, 2013 (India).
 AVTAR SINGH, COMPANY LAW 428 (Eastern Book Company 2018).
 ECONOMIC TIMES, Tata Consultancy Services Balance Sheets, Financial Statements – The Economic Times (indiatimes.com) (last visited Nov. 2, 2022).
 TIMES OF INDIA, https://timesofindia.indiatimes.com/blogs/voices/factors-affecting-the-valuation-of-your-online-business/ (last visited Nov. 4, 2022).
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