The onset of the pandemic in the year 2019 brought with it a lot of financial hardship. Many companies bore the brunt of it, many of whom faced liquidation and bankruptcy. When a company liquidates, the amounts distributed to shareholders are the ones on the balance sheet.
The total value of the assets on the balance sheet is referred to as the Book Value (BV). In this article, we shall understand what it is, and how its knowledge can help you make sound business decisions.
How Does Book Value Work?
In literal terms, book value refers to the valuation of a business based on its books of account and financial statements. Practically speaking, it is roughly equivalent to the amount investors will receive in the event of a liquidation exercise. You can analyze the BV based on market capitalization. This means that the book value sum is seen in the light of the company’s stock value.
Mathematically speaking, the book value is determined by subtracting the company’s liabilities from the company’s assets. Apart from recording the value of the business on paper, the BV also attempts a comparison with the current business value. This is done by factoring in depreciation to the assets column under the book value. This way, it can cross-reference the BV with the actual value of the business.
Book value is expressed per share. You can get this by dividing the entire shareholder equity by the amount of outstanding common stock shares. As it stands, BV can only account for tangibles within asset categories. This means that intangible assets like intellectual property and patents.
We shall go on to look at other important details concerning book value, as you will see in the coming sections.
What Is Included in Book Value?
The BV contains information that is known to be a tangible asset. Goodwill and intellectual capital are some of the components of tangible book value.
Why Is Book Value Important?
BV is a key part of the accounting valuation of businesses. There are different uses for book value, namely:
- The BV stands in as the total valuation of business should the case of liquidation arise.
- In comparison to the market value, book value determines whether a stock is overpriced or underpriced.
- It is a good fit for investors who have a strategy for value investment to find the best deals in terms of stock.
- The Book Value supplies information and understanding concerning the current state of the company.
What Is a Good Book Value?
A good BV uses a price-to-book ratio (P/B) to ensure that its helpful. In simple terms, a P/B is said to have a good BV when it is less than 1.0. It is important to note at this point that P/B results can vary by industry. This means that P/B ratios should be looked at with other company data in order to determine if it is “good.”
In terms of significance, a company with a good book value is always a number one attraction to investors. If your BV is considered good, then it means you will have a lot of business coming to you.
Can a Company Have a Negative BV?
A company can have a negative BV, which signifies that it has more liabilities than assets. In terms that are easier to understand, the company owes more than it owns. However, having negative book values doesn’t always have negative connotations and consequences.
In some situations, investors see a negative book value as a good signal. One of these situations is when there are undervalued assets on the company’s balance sheet. This is because land assets are added to their cost on the balance sheet.
Another reason is that the intangible assets developed by the business have zero value on paper (i.e on the balance sheet). As a result of this, they offer more value than the tangible assets on the balance sheet. This negative book value is also referred to as negative Tangible BV.
Book Values Main Purposes
BV as a concept was created to show at a glance how much a company/business is worth on paper. This also allows investors to assess company credibility and make investment decisions in record time. Below are some of the reasons for which book values exist:
- Enables investors to decide, choose, and invest in value stocks that appeal to them.
- It helps investors to compare the output values of two companies who are alike.
- Determines whether the stock is available for the right price or not.
- It shows the State of affairs in the company or business.
How To Calculate BV
In mathematical terms, Book Value is expressed this way:
Book Value = Shareholders’ Common Equity – Preference Stock
Shareholders’ Common Equity = Total Assets – Total Liabilities
These values can be found in the balance sheets for companies.
Example of Finding Book Value
Company F reports the following numbers at the closure of its yearly books of account:
Total Assets = $53,000
Total Liabilities = $34,000
Outstanding Equity Shares = $8,500
Preference Stock = $7,000
To find the book value:
Shareholders’ Common Equity – Preference Stock
Where also Shareholders’ Common Equity = Total Assets – Total Liabilities.
From the following formulae:
Shareholders’ Common Equity = $53,000- $34,000 = $19,000
So, book value = $19,000 – $7,000 = $12,000.
Book Value Per Share
Book Value Per Share is the amount arrived at when the book value is divided by the number of outstanding shares. When we speak of outstanding shares, we refer to shares currently held by all its shareholders. Book Value per Share helps investors to compare companies’ offerings on a per-share basis.
How To Calculate Book Value Per Share
To find the Book Value Per Share = Book Value / Number of outstanding shares
Keep in mind that Book Value = Shareholders’ Common Equity – Preference Stock
You can find these values in the balance sheets of a business.
Example of BV Per Share
Continuing from the example above:
Book Value = Shareholders’ Common Equity – Preference Stock
Therefore – Book Value = $19,000 – $7,000 = $12,000
So, Book Value per Share = Book Value ÷ Number of Outstanding Shares.
Where the number of outstanding shares is 1,000, the Book Value per Share would be:
$12,000 ÷ 1,000 shares = $12
Book Value per share = $12
What Is a Good BV Per Share?
When a Book Value Per Share is higher than the share price, the company’s shares are seen as undervalued. Where there is an increase in Book Value Per Share, then the stock in question is valuable. As a result, the share price will rise.
How Can a Company’s BV Per Share Increase?
There are some ways to increase a company’s Book Value per Share. These are:
- Repurchase of common stock from shareholders
- Purchase of more assets with generated profits
- Reduction of liabilities with profits made
Market Value vs Book Value
Many think that these two share similarities when in fact, they do not. We shall show you the difference between market value vs book value in the following sections.
What Is Market Value (MV)?
Market Value is the valuation of a company according to the stock market. In simpler terms, it is the price an asset is worth in the marketplace. For companies, Market Value is equivalent to market capitalization.
The Market Value has a fundamentally different calculation mode from Book Value. Both of them tell different stories. Market Value gives us an idea of the value of a company in the ebb and flow of the open market. On the other hand, Book Value shows us the valuation of the business on paper.
What Does It Mean to Have a MV Greater Than BV?
If market value is greater than book value, then it means that investors are forecasting positive prospects for such a company. Normally, the book value amount is always less than market value in amount. In situations like this, growth, expansion, and profit increase for the company are not far fetched.
Book Value, Fair Value, and Equity: What Is the Difference?
For a comprehensive understanding of book value, we must contrast it with other modes of valuation available. In the sections below, we will show you how BV differs from all the other valuation modes.
What Is Fair Value (FV)?
Fair value is the measure of the worth of an asset intrinsically. Fair value is employed when the true value of an asset is about to be discovered. Due to that fact, it is static most of the time.
Fair value differs from book value in several ways. However, the major difference is that FV is static, while BV is dynamic i.e it can be altered to reflect changes.
What Is Equity?
Equity value is a valuation model which requires the multiplication of the company share price by the number of outstanding shares. With thriving companies, you will find that equity value is always higher compared to book value.
Equity value differs from book value intrinsically. While equity looks at the volume of investment, BV looks at the status of the investment as written in the balance sheet.
With the knowledge gained from this article, it is safe to say that you are on your way to better your business. This is because you now know how good your valuation must be on paper to attract investors to your business.
Don’t get too comfortable though, consult your Financial Advisor from time to time, so you can position your business for much-needed gains and business volume.