Michigan Residential Builders License Practice Test

When calculating net worth, what does assets minus liabilities equal?

1. Equity

2. Net income

3. Gross profit

4. Cash flow

The correct answer is: Equity

When calculating net worth, the formula involves subtracting liabilities from assets, which results in equity. This is a fundamental accounting principle that reflects the ownership value that an individual or entity has in their assets after all debts have been accounted for. Equity essentially represents what would remain if all liabilities were paid off from the assets owned. It gives a clear picture of financial health, as it indicates the net value attributable to the owners after satisfying all financial obligations. The other terms—net income, gross profit, and cash flow—refer to different financial concepts. Net income is the profit after all expenses have been deducted from revenue over a certain period. Gross profit relates to revenue minus the cost of goods sold, thus reflecting the efficiency of production. Cash flow tracks the movement of cash in and out of the business but does not specifically represent the net worth or equity position of an entity.