Book value - What is book value?
Book value refers to the value of an asset based on the current numbers in the balance sheet, or to the total value of a company according to its financial reports
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Book value is used either to address the value of a particular asset of a business, or can be used concerning the value of a business by determining the total value of assets held.
Two types of book value
When using ‘book value’ in discussing a business, this refers to the total amount that the business is worth after all liabilities are paid off, and the total value of the intangible assets is subtracted from that of the tangible assets. The result is the book value of the business.
Book value can also refer specifically to assets held by a company. In this case, the book value of the asset is the current value taking into account depreciation. This amount should be updated and reflected in the company’s balance sheet.
Why book value is important for businesses
When used concerning the value of a business, book value is a crucial calculation for determining the actual, intrinsic value of that business. It helps potential investors by providing information that communicates whether a company is at a good selling point.
The formula for determining the book value of a company is therefore:
Total assets – Total liabilities = Company book value
An investor will typically look for companies that are underpriced, which means that they are trading at rates under their book value. This indicates that the shares that are available are selling for less than they are worth.
This comparison is known as the price-to-book ratio, and it is a formula that can be used to see the value of a company’s assets that are available to shareholders and compare that to the current price of its stock in the stock market.
Example of business book value
The book value of a company should be easy to determine according to their balance sheet. This lists their current assets and liabilities, making it easier to use the formula above to determine a book value.
For example, in 2018, Facebook reported total assets worth 97.33B. Of this, 19.6B were considered intangible assets. Their total liabilities were reported as 13.21B. Using the formula, this would then be: 77.73B (total assets - intangible assets) - 13.21B (liabilities) = 64.52B as the company’s book value.
Why book value is important for assets
When it comes to book value as it pertains to assets, it allows a business to determine the current value of the asset as it appears in their records. Note that the book value might differ from the market value but it is a good starting point for understanding the value of an asset, after taking into consideration depreciation.
The equation for determining the book value of an asset is therefore:
Original cost - Total depreciation = Asset book value
Example of asset book value
When you launch your business, you purchase a van needed for transportation of your products. The amount you pay for the van is £8,495. With some assets such as vehicles, depreciation begins instantly and can be exponential. For the sake of this example, we will keep it simple.
If you estimate that the van will have a useful life of 6 years for your business, with a salvage rate of £1,000 then according to straight-line depreciation, the value of the van would depreciate by £1,249.17 each year of use.
So, at the beginning of the third year of ownership, the book value would be determined by: 8,495 - 2,498.33 = £5,996.67. This is the original cost minus the two years of ownership (taking into account estimated salvage value) to determine the current book value.
Downsides of book value
Book value is a useful number to determine, however it can quickly become complicated by varying methods of depreciation. This applies to both book value of an asset and to the book value of a company.
Book value also might not be able to take into consideration other factors that could influence the real value of the company such as human capital or insolvency.
Book value vs market value
Another method used to analyse the value of a particular company is known as ‘market value’. Market value is based on the value of the business on the stock market. To put it simply, the market value of an asset or company is based on how much a buyer would be willing to pay.