Definition of book value: formula and calculation
What is book value?
Book value is equal to the cost of transporting an asset on a company’s balance sheet, and companies calculate it by recording the asset against its accumulated depreciation. As a result, book value can also be thought of as the net asset value (NAV) of a company, calculated as the total of its assets less intangible assets (patents, goodwill) and liabilities. For the initial down payment of an investment, the book value can be net or gross of expenses such as trading fees, sales taxes, service charges, etc.
The formula for calculating the book value per share is total common equity less preferred shares divided by the number of common shares of the company. Book value can also be referred to as ‘net book value’ and, in the UK, ‘net asset value of a business’.
Key points to remember
- The book value of a business is the net difference between the total assets and the total liabilities of that business, where the book value reflects the total value of the assets of a business that the shareholders of that business would receive if the ‘business was to be liquidated.
- The carrying amount of an asset is equivalent to its carrying amount on the balance sheet.
- The book value is often less than the market value of a business or asset.
- Book value per share (BVPS) and price to book ratio (P / B) use book value in fundamental analysis.
Understanding Book Value
Book value is the book value of the company’s assets less any receivables greater than ordinary equity (such as the company’s liabilities). The term carrying amount arises from the accounting practice of recording the value of assets at original historical cost in the books.
While the book value of an asset may remain the same over time depending on accounting metrics, the book value of a business collectively can grow from the accumulation of profits generated through the use of the assets. Since the book value of a company represents the value of stock ownership, comparing the book value with the market value of stocks can be an effective valuation technique when trying to decide whether stocks are valued. fairly.
As the book value of a business, book value has two main uses:
- It represents the total value of the company’s assets that shareholders would theoretically receive if a company were to go into liquidation.
- Compared to the market value of the company, book value can indicate whether a stock is undervalued or overvalued.
Book value per share (BVPS) is a method of calculating the book value per share of a company based on the common equity of the company. In the event of a dissolution of the company, the book value per common share shows the monetary value remaining to the common shareholders after all assets are liquidated and all accounts receivable have been paid. If a company’s BVPS is higher than its market value per share, then its stock may be considered undervalued.
In personal finance, the book value of an investment is the price paid for an investment in securities or debt securities. When a company sells stocks, the selling price minus the book value is the capital gain or loss of the investment.
There are limits to how accurately the book value can be an approximation of the market value of stocks when mark-to-market is not applied to assets that may experience increases or decreases in value. Merchant.
For example, real estate owned by a company can sometimes gain in market value, while its old machinery can lose value in the market due to technological advancements. In these cases, the carrying amount at historical cost would distort an asset or the true value of a business, given its fair market price.
Price / pound ratio
The price-to-book ratio (P / B) as a valuation multiple is useful for the value comparison between similar companies in the same industry when they follow a uniform accounting method for valuing assets. The ratio may not be used as a valid valuation basis when comparing companies from different sectors and industries, as some companies may record their assets at historical costs and others value their assets at market price.
Consequently, a high P / B ratio would not necessarily be a premium valuation, and conversely, a low P / B ratio would not automatically be a discount valuation.