Book value is the net value of an asset on a company’s financial balance sheet in the accounting world while in the financial or investing world, book value is understood as the total value of all the assets of a company minus its liabilities.
Book value is a company’s equity value that is expressed in the financial statements. It is solely connected to the company’s market capitalization and can be calculated by subtracting its liabilities and the company’s intangible assets from its total assets.
Book value shares the accurate picture of a company’s shares. This article will discuss book value definition, book value formula, and the difference between net book value and market value.
What is Book Value?
Definition: Book value is defined as the equity value of companies as it relates to their accounts or books as mentioned in the company’s financial statements especially in the balance sheets. It helps in finding the real value of a company. In the UK, book value is popular as net asset value. It is also known as carrying value.
You may also understand it as a financial measurement that determines the company’s net worth if the company liquidates all of its assets and clears the payments of all liabilities such as debts and expenses. The book value of a company is generally lower than its market value.
Another reference of net book value is the theoretical amount that an investor will receive if the company is terminated. Book Value offers the financial status of a company to the investors and its capability as an investment. It’s always necessary for each investor to make a better decision for investing capital, and book value might alleviate the determination procedure for them.
Importance of Book Value
Book Value is considered an essential key in valuation as it represents the moderate and accurate picture of a company’s image. It is used by investors to find the total worth of a company.
It enables the investors to find good deals on the stocks, especially when they think that the company is undervalued or the rising price of the stores.
The value is determined by the available historical data from the company and certainly isn’t a subjective figure. By evaluating Book Value, investors and market analysts can get a good outlook of a company and its net worth for investing.
Moreover, Book Value is essential for investors to get an overview of the company’s finance and worth. So, Book Value is important in various ways like,
- Analyzing the stock of the company, whether it is undervalued or overvalued
- Indulges in market analysis and compares with other company’s stock value
- Collects proper details on working capital, that is, the available money for the company’s day-to-day operations
- Calculation of several financial ratios that include Working Capital Ratio, Debt to Equity Ratio, Debt Ratio, Price-to-book ratio, Current ratio, etc
How to Calculate Book Value with Formula?
You can calculate it by subtracting the company’s liabilities (debt, expenses) from the company’s assets (the worth of all goods, properties, funds, and other things).
Using the following formulas, you can determine the Book Value of an asset, Book Value of a company, total assets, and total liabilities.
Book Value Of An Asset = Original Cost – Accumulated Depreciation
Book Value Of A Company = Total Assets – Total Liabilities
Total Assets = Non-current Assets + Current Assets
Total Liabilities = Non-current Liabilities + Current Liabilities
Finding Book Value on Company’s balance sheet
On the company’s balance sheet, Book Value is listed in the form of assets (the difference between the asset’s original cost and accumulated depreciation).
For each company, the Book Value is equal to the shareholder’s equity in the balance sheet that is the subtraction between the company’s assets and liabilities.
Book Values vs Market Value
The book value is simply understood as the value of a business in its accounts or books, as mentioned in its financial statements. It is the amount that stockholders would get if they liquidate the company. Mathematically, you can get it by differentiating the company’s total liabilities from the company’s total assets.
The market value is associated with the value of a company as per the stock market. It refers to the price that an asset might get in the marketplace. For companies, it can be understood as market capitalization. You can calculate the market value by multiplying the company’s outstanding shares with its current market price.
Book Value Examples
According to Microsoft Corp.’s (MSFT) balance sheet for the 2020 fiscal year ending June, the company’s total assets were around $301 billion, while their total liabilities were around $183 billion.
This way, their book value was $118 billion ($301 billion – $183 billion).
Market Value Examples
At the end of the Microsoft fiscal year on June 30, 2020, the company had 7.57 billion shares outstanding, plus the company’s stock price closed at $203.51 per share on that day.
Hence, their market value or market cap was around $1,540.6 billion (7.57 billion * $203.51).
Definition of Book Value per share (BVPS)
Book Value per share is a measurement of the common shareholder’s available equity according to per share. In another way, it refers to the ratio of the public common equity to the total number of outstanding common shares. You can use the below-mentioned formula to evaluate Book Value per share, and that is,
Book Value per share = (total shareholder’s equity – preferred shareholder’s equity)/average number of common shares
On that note, the value of an average number of expected sales is needed instead of the total number of standard sales to prevent significant events like stock issuances or stock buybacks from hampering the outcome of the calculation.
Book Value per share is another industrial metric that the inventors often analyze for the company’s stock. If BVPS is higher than the market value, the company is undoubtedly trading the stocks in less than its net worth, and hence, it is undervalued. On the other hand, the lower BVPS than the market value promotes the trade of the stocks in more than the company’s worth, and therefore it is referred to as overvalued.
Tangible Common Equity
Tangible Common Equity is a significant variant of Book Value that the US Federal Government has recently introduced in the calculation of troubled banks.
Tangible Common Equity can be calculated from the subtraction of Book Value and intangible assets, goodwill, and preferred equity. It helps the company to determine the most conservative value and the best approximation of its value.
So, Tangible Common Equity evaluates the preferred equity from the tangible book value. It helps the companies to do a better job of estimating the value of the company to its holders and, specifically, the common stock. In a word, Tangible Common Equity provides the effective valuation of the book value to the stakeholders and investors of the company.
Book Value vs Equity
On a balance sheet, book value is equal to the shareholders’ equity value but in reality, they both are different.
Book Value is measured by subtracting the company’s assets value from the company’s liabilities and intangible assets. It can be greater than zero or less than zero. Sometimes, book value is equal to zero as well.
On the other hand, equity is the total value of all shares of the company and all the earnings by the company. Its value also can be greater than, less than, or equal to zero.
Limitations of Book Value
Book values also face few limitations, and those are
The accuracy of book value is quite important, and that requires the proper adjustment that is depreciation. But the availability of different adjustment methods, accounting principles, and other concerned topics that offer the complication in the calculation of book values.
2. Not updated
Rare publications of the balance sheet are a major problem of Book Value as it is updated quarterly or annually. But, investors need to rely on the latest figures in each month and quarter upgrade of balance sheets often discomforts the investors.
3. Intangibles are excluded
Only adding tangible assets and not considering intangibles such as intellectual property and branding is one of the major drawbacks of book value. Here, companies that completely depend on human capital as intangible assets are very difficult to evaluate.
4. Less focus on growth
Assets and liabilities are unable to represent the full image of the company. Moreover, the companies that invest a huge amount in development often experience loss, and that results in negative book value. If the figure is used to evaluate the price-to-book ratio, the value can suggest the undervalued or distressful status of the company.
5. No proper heed over quality
Book Value doesn’t exemplify the company’s assets or its marketing price. Assets can offer value to the company over time when the equipment can get outdated or less reliable. So, Book Value doesn’t reflect the company accurately.
Book value is often referred to as the ‘carrying value’ that is recorded in the balance sheet of a company on a given date. It is an accounting measurement that helps the companies to grow collectively and attracts a huge number of investors and shareholders.
So, book value is a largely used financial metric to do asset valuation and determine a company’s actual merit. One of the most important cautions that the investors or traders should follow before investing capital in stocks is to pay attention to the company’s Book Value and its profile.
Book Value is the only way to check the overview of a company and the status of its stocks regarding its status as over-valued or under-valued.