What is a Book Value?

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Definition:

A company’s book value is all of its tangible assets minus liabilities, while the book value of an asset is its current worth on the balance sheet.

🤔 Understanding book value

Book value is the amount a company assigns to an asset on its books (financial records). When a firm buys an asset, the purchase price is the book value. As the asset is used, it may become less valuable. If the asset is a capital expense (something that will be used for many years), its value is typically depreciated (reduced) each accounting period. Its book value becomes the original price minus accumulated depreciation and any impairments (other significant reductions in value). The book value isn’t necessarily the same as the market value (what the asset would sell for). A company’s book value is a measure of its worth if it were liquidated today — the sum of its total assets, minus its intangible assets (like the value of the brand name) and all liabilities.

Example

Say you own a small landscaping business and buy a lawnmower for $1,000. On your balance sheet today, the lawnmower is listed as an asset with a book value of $1,000. Over the next year, you use that lawnmower every day. Now it has grass stains, dings, and chipped paint. You know the used mower is not worth what it was last year. So it should not be a surprise when the asset’s book value falls to $900. The other $100 is called depreciation (a reduction in value due to wear and tear). The purchase price minus depreciation is the book value.

Takeaway

Calculating a book value is kind of like determining the value of a building over time…

Since you first purchased the building, perhaps some of the shingles have started to fall off, but maybe you also replaced the gutters and added a fancy new security system. To find the value of the building, you have to consider both the flawed roof (liabilities) and the new improvements (assets). Similarly, when calculating book value of a company, you must take tangible assets and subtract liabilities, all recorded on a company’s balance sheet.

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What is book value?

Book value can apply to an asset or a company. For an asset, the book value is the purchase price minus all reductions in value. Those can include accumulated depreciation (in accounting, the process of reducing an asset’s value over time) and impairments (a permanent accounting reduction when an asset declines in value by more than depreciation).

Not everything a company buys has a book value. Small purchases are often recorded as expenses rather than assets, since they’re used up in the course of operations. But other purchases, especially large ones, have value over a longer period. Known as capital expenses, they must be depreciated on the company’s books over many years. Examples can include computers, copiers, cars, and commercial real estate.

The formula for depreciation depends on the type of asset. Three common formulas are:

  1. Straight-line: Reduces the asset’s value by same amount every year over its useful life.
  2. Units of production: Reduces the asset’s value based on how often it’s used.
  3. Double declining balance: Reduces the asset’s value by a greater share in earlier years and a smaller share later on.

A company book value is basically its net worth. It is determined by subtracting liabilities from the value of the company’s tangible assets. It doesn’t include intangible assets, like patents or brand recognition.

What is the purpose of book value?

Book value gives investors a better sense of what a company’s assets are worth. If a company simply kept the purchase price of capital assets (items used over several years) on its books, that would overstate the value of the company. Just like a used car is not worth the same amount as a new one, a piece of equipment declines in value as it is used.

As a result, accounting standards and federal tax rules require that many assets be depreciated over several years. This process provides a structured set of rules for how to value assets over time, rather than relying on someone’s opinion.

The book value of a company tells investors how much a company could be worth if it sold all its physical assets and used the proceeds to pay off its debts. In theory, it’s how much shareholders would get back if the company were liquidated. It’s an estimate of the company’s value based on what’s on its books, not how much investors would actually be willing to pay for it. Comparing a company’s book value to its market value can help investors evaluate whether its stock is undervalued or overvalued.

What is the difference between book value, fair value, and market value?

There are a few ways to assign value to a company, stock, or asset:

  • Book value is the value an accountant gives a capital asset in a company's financial records, namely its balance sheet. It’s the purchase price minus depreciation and any impairments up to that point. In the context of a business, it refers to the total value of the company’s physical assets minus its liabilities.
  • Fair value is the amount that an investor, owner, or analyst assigns to something. It is a subjective estimate (educated guess) about what a company, stock, or asset would fetch on the open market. A mark-to-market valuation estimates how much a company would get if it sold an asset today.
  • Market value is what someone actually pays for something. It is the price determined by the market – in other words, a willing buyer and seller. When an asset is sold, its market value is discovered. At that point, it is removed from the balance sheet, and the sale price enters the income statement. The market value may be higher than, lower than, or equal to the book value.

How do you calculate the book value of individual assets?

To determine the book value of a capital asset, start with the purchase price (also called the cost basis). Then subtract all of the depreciation up to that point. If the asset suffered some unusual reduction in value, like learning that a building has asbestos, it might also receive an impairment.

Book value = Purchase price – Accumulated depreciation – Impairments

Say a company owns a building that it purchased for $1M in 2010. In 2020, the book value of the building would be $1M minus a decade of depreciation and any impairments. For simplicity, let’s use a straight-line depreciation formula over 39 years (the schedule federal tax rules dictate for commercial real estate). Therefore, $25,641 per year gets deducted as depreciation ($1M / 39 = $25,641). We will also assume that the building suffered $100,00 in irreparable damage during an earthquake, resulting in an impairment.

In this case, the book value of the building in 2020 is:

$1M- ($25,641 x 10) - $100,000 = $643,590

That doesn’t mean it would sell for that amount — The market would determine that. But that is the figure recorded on the company’s balance sheet. Not all assets follow a straight-line depreciation schedule, and the number of years over which depreciation happens varies depending on the type of asset. You may want to consult an accountant to make sure you are calculating book value correctly.

How do you calculate the book value of a company?

The book value of a company is essentially its net worth:

Company book value = Total assets – Intangible assets – Total liabilities

If a company had $5M worth of physical assets and owed $3M in debts, its book value would be $2M.

To get total assets, add up the book values of all of the company’s capital assets. Also include cash, cash equivalents, inventory, investments, and other assets that do not depreciate. Don’t count intangible assets, such as brand name recognition or patents. Liabilities include loans the company has taken out, bonds it has issued, sums it owes to vendors, and other debts.

Basically, the book value of a company is an estimate of what would be left over if the owners sold its tangible assets and used the proceeds to pay off liabilities. This is sometimes called the book value of equity.

How do you calculate book value per share?

If you’re a value investor (someone who looks for companies whose stock price may be undervalued), you might be interested in determining a company’s book value per share. This refers to how much each share would theoretically be worth if the owners liquidated the company.

To calculate book value per share, first determine the book value of the company. Take the total assets, and subtract intangible assets and liabilities. Then, divide the book value of the company by the number of outstanding shares of common stock.

Book Value per Common Share = (Total assets – Intangible assets – Total liabilities) / Number of common shares outstanding

What is a good book value?

If a company has a negative book value, that indicates that it has more liabilities than assets it can use to pay them off. In general, that could indicate a potential problem. The company may be overleveraged (hold too much debt) and be at a higher risk of bankruptcy.

A good book value is usually determined by comparing it to the market value of a company. This metric is called the price-to-book ratio:

P/B ratio = Stock price / Book value per share

The typical price-to-book ratio varies by industry. For example, you would expect a car manufacturer to have more physical assets than an internet-based company. As a result, it may make sense to compare companies within the same industry or a firm’s current ratio to its historical ratios. Value investors typically look for a price-to-book ratio below 1 when hunting for stocks that are potentially undervalued.

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