Generally speaking, net income is used to refer to the remainder of a business’s revenues in a particular period of time once the costs of businesses have been deducted from them. This means not just the cost of sales but also operating expenses, taxes, interest, and other costs as well. As a result, net income is the single most common measurement of a business’s profitability, which can be thought of as being whether its financial position has been improving or not. However, it is important to note that net income is not a comprehensive measurement of a business’s well-being, with an excellent example being how a business with a positive net income can still struggle to meet its short-term obligations in each period because it struggles to bring in enough cash.
Likewise, a person’s net income is just their gross income minus their taxes and other deductions. As a result, it can be considered a critical measurement of a person’s financial wellbeing as well, though once again, it is far from being the sole factor that can provide useful insight into such a nebulous but nonetheless important concept.
What Is Net Worth?
Some people have been known to mix up net income with net worth, but it should be noted that the two have little in common. After all, while net income is a measurement of the change in an economic entity’s financial circumstances over a particular period of time, net worth is a measurement of an economic entity’s financial circumstances at a particular point in time. Simply put, net worth is a business’s total assets minus its total liabilities, meaning that some people might be more familiar with it as either owner’s equity for a sole proprietorship or a partnership or shareholders’ equity for a corporation. In a real sense, net worth can be considered the owners’ claim to the business’s assets, meaning that its implications are both numerous and varied in nature.
A person’s net worth is much the same as a business’s net worth. It is a simple and straightforward figure that can be calculated by summing up their wealth, whether in the form of cash, tangible assets, and intangible assets, and then deducting the outstanding sums that they owe to other parties. Generally speaking, a high net worth is desirable for the simple reason that it means that a person is in a strong financial position, though it should be remembered that it is not something that can be used to tell the whole of the story.
How Do Net Income and Net Worth Compare with One Another?
Both net income and net worth are important, but they are not important for the same reasons. Generally speaking, people want a high net income because that means that their financial position is strengthening at a faster pace. After all, a high net income means that they have more money to spend, whether on satisfying their needs, satisfying their desires, or investing into their investment portfolios so as to increase their income in future periods. In contrast, people want a high net worth because that means that they are already in a strong financial position, which may or may not mean that they have money to throw around because someone who has a lot of assets doesn’t necessarily have a lot of liquid assets.
However, there are a number of reasons that people should look at their net income before looking at their net worth. First, having a positive net income is what ensures that someone will be capable of meeting their short-term obligations. Granted, people can sell off their assets in order to generate the cash needed to meet those same obligations, but the problem with illiquid assets is that it takes considerable take and effort to find a buyer. Never mind a buyer who is willing to pay what an illiquid asset is actually worth. As a result, it is not uncommon for people to take a loss when they are forced to sell their assets to generate enough money for the short run.
Second, it should be mentioned that a net loss is not unsustainable in the long run. At some point, a person will run out of assets to sell, meaning that there is a limit to how many net losses that they can sustain by using their net worth. As a result, most people should focus on making sure that their net incomes are sufficient for their needs before they start worrying about their net worth, though there can be exceptions to this rule.