Businesses can be valued in many ways. One example is the book value, which looks at a company's assets to determine equity. Keep reading to learn more about how a company's book value is determined and what it means for both businesses and investors.
What is book value?
A business's book value is determined by subtracting existing liabilities from the total value of its assets. It's usually looked at in relation to stock value and is reported as a figure on the financial statements.
Book value is a useful figure for companies to track their growth, but it also serves as an essential indicator of real-time value for investors. To aid in this assessment, book value is often listed per share. Total shareholder equity is divided by the number of outstanding stock shares to arrive at this per-share figure.
Book value vs. market value
While book value uses factual company data and assets to arrive at an impartial valuation figure, market value offers a different way to assess value. A company's market value is based on what the business is worth on the stock market or how much a buyer would conceivably pay.
Both figures are important for investors, but those using a value investing strategy will be more interested in the book value. If stocks are currently trading below this number, they are considered a good deal as they're likely to rise to bring them in line with what the company's actually worth – the book value.
Book value vs. fair value
Book value is also different from a company's "fair value." Fair value accounting methods adjust the value of assets to reflect changes in market prices. For companies in volatile markets, this can lead to significant changes in asset value from one accounting period to the next.
Book value formula: how is book value calculated?
We've mentioned above that book value is calculated by taking the total value of a company's assets and subtracting its liabilities.
The book value formula, therefore, looks like this:
Book Value = Company Assets – Company Liabilities
It's also helpful to determine what defines assets and liabilities in this case.
Assets include the value of all current and noncurrent assets, accounting for depreciation.
Liabilities include both current and non-current liabilities.
Book value is calculated using a company's balance sheet. These accounting statements show total asset value, including the cost of acquiring the asset along with its accumulated depreciation.
What are the benefits of tracking book value?
The main benefit of using the book value formula is its simplicity. It relies on figures from the company's balance sheet, including asset and liability value. The one thing to keep in mind is to factor depreciation into asset value. With these figures, you can gain an accurate view of the company's current, tangible value.
What are the limitations of the book value formula?
For investing purposes, there's one main flaw in using book value as a sole financial indicator. While this figure tallies up the value of all tangible assets, it doesn't include the value of intangible assets. Tangible assets are those that can be counted, while intangible are things like intellectual property. A start-up business designing apps could have a high market value based on its potential for growth, but a high percentage of this value is found in ideas (future app developments) rather than tangible assets (products to sell). In this case, its book value would be lower than the company's actual worth.
To overcome this issue, investors often use the book value formula as a comparative tool. If the app company mentioned above has a lower price-to-book-value ratio than a similar tech start-up, this might indicate it's a good bargain.
There's no single method of valuation that suits all purposes. However, book value is a useful measure of real, tangible worth rooted in a company's accounting statements.
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