Net Asset Value (NAV) – A Short Introduction and its Proper Application

Net asset value is something that all accountants and financial experts are intimately familiar with. However, for most people, accounting terminology tends to be little more than gibberish. With the world’s tumultuous economic state and unpredictable market, knowing even the simplest, most basic information about finance can help in safeguarding assets and investments.

To help with this goal, let’s start with one of the basics: the Net Asset Value. Here is a short primer on Net Asset Value and it’s usage in the financial and investment world.

So what is Net Asset Value?

Simply put, this is the value you get from subtracting the value of an entity’s liabilities from the value of its assets. It is sometimes referred to as book value. It is different from market capitalization because the former represents the price at which the entity or company is valued in the market while net asset value is used to determine its asset-liability position.

How is Net Asset Value used in business?

The net asset value, together with market capitalization, is a tool used by investors to determine if a public company’s shares are a good investment. Armed with information on the assets and liabilities of a company, investors can determine if a company is a risk or if it has significant growth potential. In the latter case, they may opt to pay more than the computed net asset value to take advantage of this potential.

More often than not, a company usually has a lower net asset value compared to its market value. If the reverse is true, then the consensus by most business analysts is just to let the company wind-up its affairs rather than keep it operational as a going concern.

In relation to Mutual Funds, what does Net Asset Value refer to?

First off, a mutual fund is a type of investment scheme made up of funds contributed by many investors. The resulting mutual fund is then used to invest in securities (bonds, money market instruments, stocks, etc.). The end goal is for the fund to profit from the investments in order to benefit the investors.

In this context, the net asset value refers to the price per share of the mutual fund. It is arrived at by getting the total value of the securities in fund’s portfolio, subtracting the liabilities and then dividing the resulting value by the number of outstanding fund shares.

It’s basically the dollar value of a share in the mutual fund. Net asset value is computed daily although the variations of the computed value tend to be minimal. The net asset value is the same as the redemption or sale value of a share in an open-end mutual fund but for a closed-end mutual fund, the market price and the net asset value tend to differ.

When computing for net asset value, always remember this formula: assets less liabilities. If you need to compute for a per share value, just divide the difference with the number of shares. It’s a simplistic way of looking at it but it’s an effective way of remembering and understanding net asset value and what it represents.

Tagged fund portfolio, Mutual Fund, NAV