If a person says they are worth $10 billion but they own a US company that is privately held, (making it a pass-through entity) and that company owes $20 billion, how is that person allowed to say they are a billionaire? Thank you. Btw: this is an ACCOUNTING question, not a POLITICS question.
In: Economics
It’s a division of personal and business. The business has separate liabilities and assets as the person, even though the business itself is an asset for the person. This is because if the business is an LLC, an s-Corp, or c-Corp, it is a separate entity from the person who owns it.
Determining a person’s net worth is simple, it’s just assets minus liabilities.
Determining the value of a business is more complex than figuring out a person’s net worth. For a business, it’s not as simple as assets minus liabilities (equity), though it is a factor in determining what the business is worth.
Furthermore, not all debt is bad. Infact, in terms of business, almost all debt is good, especially for real estate. It’s a concept called leverage, and it’s very powerful. It’s actually very normal for businesses to carry a large amount if debt because it helps them make more money than if they operate strictly with cash.
Many people see debt as something bad because of the debt they’ve experienced. If you max out a credit card or take out a loan to buy expensive yard equipment for your house and had to pay $250 a month to pay it all off, that’s bad debt if you’re not making any money off that. But if you used that lawn equipment to start a landscaping business that makes $1200 a month, then it becomes good debt because now you’re using that debt to make a profit. It gets more complicated that that the bigger you get, but that’s the general concept of leverage.
Now let’s get a little more technical. Every company has what’s called a Balance Sheet. A balance sheet is a financial statement that lists all the companies assets and all of the company’s liabilities. If a company owns theme parks, the loans taken out to buy the land and build the rides go under liabilities. The value of the park goes under assets. And when we subtract the total of liabilities from assets, we get equity which is a factor for what the company that owns the theme parks is worth.
Individuals have balance sheets too, you can even make one for yourself. If you have a car loan, it would go under liabilities and the value of the car would go under assets. Same thing if you own a house, the mortgage goes under liabilities and the value of the house goes under assets. You bank account also goes under assets, and so does any retirement accounts or brokerage accounts.
The person who owns the theme park business has their own balance sheet, and their theme park business goes under assets on their balance sheet because it makes them money even though the company has debt exceeding the person’s net worth. The company’s liabilities are the company’s, not the individual’s.
Latest Answers