Book Value is defined as the total value of a company if it were to liquidate its assets and pay back its liabilities, or the value of the company according to the financial statement. Book value (BV) is also sometimes referred to as “shareholder’s equity.”
Business Book Value Equation
The book value is calculated by subtracting intangible assets (like patents) and liabilities (including debt, accounts payable, and notes payable) from the value of the company’s total assets (including any land, equipment, and real estate).
Book value = total assets – intangible assets – liabilities
Book Value Uses
Understanding a business’s book value allows you to know that portion of a company’s assets to which shareholders would be entitled in the event the company was liquidated. It’s a measure that allows investors to know whether or not it is a good time to purchase or invest.
Book Value Vs Market Value
While the book value is the value of the company according to its financial statements, the market value is the value of the company according to the stock market if it’s a publicly-held company, or to investors if it’s not. Market value is calculated by multiplying outstanding shares by its current market price per share. BV allows interested parties to determine whether the company’s stock is over-or undervalued, when compared to it’s market value.
When the market value is greater than the book value, the market believes that the company’s assets have a higher earning potential. Most profitable companies will have a market value that is higher than the book value.
When stock trading prices for a company fall at or below BV (a price-to-book ratio below 1.0), the company is undervalued and shares are trading at prices lower than what they are actually worth. This means that the company’s book value is greater than the market value, and the market may have reason to believe that the company’s assets have lost their ability to generate a profit or a return on investment at the same rate in the future.
Book Value Limitations
While book value certainly has purpose, it’s important for business owners and investors to understand its limitations. BV is only a representation of numbers on a balance sheet, and does not factor in any additional market data or the value of the company’s intellectual property (IP) which has not been recorded in the accounting records. Such IP may include items such as trade secrets, customer lists and contracts, employment agreements, and research and development for new products and services to name a few. BV should be only one tool among many used when valuing or analyzing a company or its stock for sale.