What is Book Value? Its Meaning, Advantages and Limitations
Key Highlights
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The Book value is a company's net worth, as reported in the balance sheets.
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Investors can use this financial metric to determine whether the stock is undervalued or overvalued.
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To determine book value deduct total debt from the value of all physical assets.
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Book value doesn’t take into account the intangible assets of a business. This decreases a company's shareholder equity than its real value.
Book Value Meaning
Book value is the net value of a company after deducting the total liabilities. It is found by subtracting the debt from the value of all its assets. Investors can also consider the book value of an individual asset. It is the value of the asset after deducting its accumulated depreciation from the original cost.
Calculating Book Value
To determine the book value, subtract the liabilities from the assets’ value. The total asset’s value includes both current as well as fixed assets.
Formula:
Book value = Total Assets – Total Liabilities
However, the value of intangible assets cannot be included during liquidation. So, some analysts do not include them in book value calculations. Here, the book value formula is as follows:
Book value = Total Assets – (Intangible Assets + Total Liabilities)
Example:
Let’s look at an example to understand how the formula works. The following table shows the assets and liabilities of a company.
| Particulars | Amount |
|---|---|
Assets | |
Current Assets | |
Accounts Receivable | Rs. 75,000 |
Inventories | Rs. 52,000 |
Cash and Cash Equivalents | Rs. 30,000 |
Fixed Assets | |
Property, Plant, and Equipment | Rs. 5,20,000 |
Land and Buildings | Rs. 4,00,000 |
Total Assets | Rs. 10,77,000 |
Liabilities | |
Current Liabilities | |
Accounts Payable | Rs. 60,000 |
Short-term debt | Rs. 85,000 |
Non-current Liabilities | |
Long-term debt | Rs. 4,00,000 |
Other non-current liabilities | Rs. 60,000 |
Total Liabilities | Rs. 8,05,000 |
So, Book Value = Total Assets - Total Liabilities
= Rs. (10,77,000 - 8,05,000)
= Rs. 2,72,000
Therefore, the book value of the company is Rs. 2,72,000.
Measures of Book Value
The book value can be measured in the following ways.
Book Value per Share (BVPS) Book value per share (BVPS) calculates the book value of a company's equity held by common shareholders on a per-share basis. A company's stock may be cheaper if its book value per share (BVPS) exceeds its market value. This indicates that the current stock price doesn’t accurately represent the worth of the company's assets.
Formula:
Book Value Per Share = (Shareholders’ Equity – Preferred Equity) / Weighted Average of Common Shares Outstanding
Price-to-Book (P/B) Ratio The price-to-book value ratio is also referred to as the price-equity ratio. The P/B ratio is the ratio between the book value and the market capitalisation.
Formula:
P/B ratio = Market capitalisation / Net value of assets
Advantages of Book Value
Now that you understand what book value means, let's look at some of the benefits of using book value.
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Asset valuation: Book value gives investors a comprehensive picture of the company's financial situation. It accurately determines its assets and liabilities.
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Helps in investment decisions: You may assess the profitability of an investment using book value. A stock may be cheap if the market value of its shares is less than its book value per share. So, it can be a potential investment opportunity.
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Evaluation of liquidity: Investors can determine a company's capacity to pay its debts by looking at its book value. A firm may have a positive net worth if the book value of its assets exceeds its liabilities. So, it is considered financially sound.
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Risk management: You can determine the amount of risk of an investment using book value. A firm with a high book value per share is usually less risky.
Limitations of Book Value
The following are some restrictions on book value.
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Periodic publication: The book value is usually released quarterly or annually. So, it might not accurately represent the assets and liabilities of a company at its current market value.
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Historical Costing: The calculation of book value is based on previous costs. It may not accurately represent the existing market value of an organisation's assets. This may result in an incorrect assessment of a company's value.
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Inappropriate for labour-intensive businesses: In some businesses the labour costs are quite high. However, book value does not consider intangible assets like employees or intellectual property. This is a major restriction for labour-intensive businesses.
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Industry-specific limitations: In industries like technology or pharmaceuticals intellectual property and research activities play a major role in determining its overall value. So, book value may not be useful here.
Difference between Book Value and Market Value
Book value and market value are two popular metrics. They are often used simultaneously to assess a company. However, they are not the same. The main differences are listed below.
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The market value or market capitalisation is the total value of all the outstanding shares of a company. It is the estimation of a business's value. Whereas, book value is the total value of assets after deducting the liabilities. It is based on the company's financial accounts.
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At times company's market value exceeds its book value. So, it implies that the investors value the company's future earnings and management prospects. However, even though a firm has a high book value, its market value may be less than its book value. It may mean the market is less optimistic about the company's ability to generate profits.
| Feature | Book Value | Market Value |
|---|---|---|
Definition | Total value of assets minus liabilities | Total value of all outstanding shares |
Basis | Historical cost of assets and liabilities | Estimation of future earnings and management prospects |
Source | Company's financial accounts | The market price of shares |
Fluctuations | Relatively stable, changes with depreciation and purchase of assets | Highly volatile, reacts to market sentiment and news |
Interpretation | Represents the company's net worth | Represents investor perception of the company's future value |
Relationship | Market value can be higher, lower, or equal to book value | Difference between market and book value can indicate investor confidence or concerns |
Conclusion
Book value is a company's equity value as shown in its financial accounts. Its calculation involves subtracting outstanding debt from the value of assets. Companies update it in the balance sheet on a regular basis. Book value might be useful to determine a company's worth, particularly for companies in the financial sector. It may be used in different financial metrics like price-to-book ratio and book-per-value share. However, don’t rely on the book value while investing. It is necessary to compare various ratios and factors to properly anyalse a company's value.
FAQs on Book Value
How is the return on equity calculated using book value?
Divide the net income by book value to find the return on equity.
Can companies have a negative book value?
Yes, companies can have a negative book value. It can occur when liabilities are more than assets. A company's negative book value indicates bankruptcy.
Are book value and shareholder’s equity the same?
Yes, book value and shareholder’s equity same. Book value represents the assets remaining for the shareholder’s after deducitng liabilities.
Is goodwill included in the book value?
Yes, goodwill is included in the book value if it is listed on the company's balance sheet. Goodwill is the premium paid for an acquisition over the fair value of the assets.
How is book value different for different types of assets?
Book value may vary for different types of assets based on the method of accounting. For instance, tangible assets like property and equipment are recorded at historical cost. However, the intangible assets may be subject to impairment charges.
