Tangible net worth is an estimate of the net worth of an entity that excludes all intangible assets such as trademarks, patents, and intellectual property, etc. The formula for calculating total net worth is as follows:
Tangible net worth is used to assess a company’s actual physical net worth without the need to include all the assumptions and estimations involved with the valuation of intangible assets. Lenders use the figure to determine the borrowing party’s “actual” net worth and assess the borrower’s ability to support and pay back loans.
What are Debt Covenants?
Debt covenants are promises or agreements entered into by the borrowing party to comply with the terms agreed upon while discussing the loan agreement. They are generally restrictions or certain parameters imposed by the lending party that the borrowing party agrees to in exchange for a loan. In other words, they are certain benchmarks that the borrowing party agrees to adhere to in exchange for a loan. They are also generally referred to as “bond covenants.”
Tangible Net Worth: Use in Debt Covenants
Tangible net worth is an important component of debt covenants. It is considered very important by most lending parties because, as mentioned earlier, it can be used to assess a company’s actual physical net worth, while not having to include all the assumptions and estimations involved with the valuation of intangible assets.
The calculation of the tangible net worth allows the lender to evaluate the borrowing party’s ability to support and settle its debts. If a lender puts forward a condition in their loan agreement stating that the agreement will only be valid as long as the borrowing party maintains a certain minimum percentage level of tangible net worth over the borrowing period, it is an example of one being used as a debt covenant.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: