What Is the Book Value Formula? (With Factors and Examples)
By Indeed Editorial Team
Published May 27, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Knowing how to evaluate a business's financial condition is essential for accountants and investors when making investment decisions. Book value is one of the ways to assess a business's financial health using its total assets and liabilities. If you work in business, finance, or investing, understanding a business's book value can help you make effective financial decisions.
In this article, we define book value, discuss its importance, explain the difference between market and carrying values, reveal the financial measures that contribute to it, and provide formulas and examples to show how to calculate the book value.
Understanding the book value formula
Before using the book value formula, it may help to first review the definition of book value and the difference between book value and market and carrying values.
What is book value?
The book value provides the cost of an asset that a business records on its balance sheet. To calculate the book value, subtract the asset's accumulated depreciation from its total cost. This gives the total reduction in its value over time. Companies may also own several assets, and their book value represents the current value of all the assets minus their liabilities or outstanding debts. A company's book value is the net amount of money it's worth if the shareholders decide to liquidate it without selling any of the assets at a loss.
After the liquidation of a business, the shareholders typically distribute the money amongst themselves. Book value also goes by the name of shareholders' equity because when investors buy shares in a company's stock, they're buying a small part of its total assets. Book value per share is the term that represents the book value of a share. The book value can be the initial investment outlay, such as the taxes, charges, and trading costs.
Book value vs. market value
An asset's carrying value is the price investors are willing to pay for it on the open market. It shows the company's worth based on the total value of its outstanding shares in the market. Its carrying value can differ significantly from its book value because of certain factors, such as intangible assets and future growth prospects. Value investors typically consider these factors during market valuations. If the shareholders decide to sell the business, these factors have a significant impact on its sale price.
For example, a company that designs computer software programs and mobile apps primarily depends on its ideas and the right to create its apps. The company's open market value can be much higher than its book value when investors consider intangible assets, such as intellectual property. The higher price doesn't necessarily indicate an overpriced business. It simply shows that some assets that attract investments are unquantifiable on a balance sheet.
Book value vs. carrying value
An asset's carrying value is similar to its book value, as it's the cost the accountant records on the business's balance sheet. For a recently purchased item, the carrying value is the original purchase cost. As the company constantly uses the asset, its value may change. When preparing a balance sheet for the item, an accountant can either use depreciation or amortization to spread its value over its useful life.
Depreciating or amortizing an asset enables the business to carry the cost of the asset over multiple accounting periods, which becomes its carrying value or the monetary value. Amortization and depreciation are similar when valuing tangible assets, such as plants and equipment. Amortization is different from depreciation, as it can recognize the decline in value of intangible assets, such as goodwill and patents. Mathematically, a book value is the same as a carrying value, but investors commonly use the book value when evaluating an entire business rather than a single asset.
The financial measures that contribute to determining a company's book value
There are specific financial measures that influence a company's book value, and these include:
Mark to market accounting
Mark to market accounting or valuation involves measuring the fair value of an asset or liability based on the current market price or the price of similar assets or liabilities. Fair value is the estimation of the price for which an asset can sell, which is fair to both the buyer and the seller. Mark to market or fair value accounting helps provide a realistic approach to appraising a business or company's financial situation based on the current market conditions.
When a business's book value is a proxy to its shares' market worth, mark to market helps accountants accurately value the assets that may experience increases or decreases in their market values. For example, if a construction company invests in real estate and, at the same time, purchases machinery. Over time, the real estate value may increase while the value of the machinery decreases. Mark to market can help the business accurately value these assets so that the book value represents the company's actual value based on its market price.
Price to book ratio
The price to book or market to book ratio is a financial valuation metric that helps measure a company's current market value relative to its book value. It shows how the market perceives a business's stock value. It also enables investors to know how much equity they're paying for each dollar in total assets.
If similar companies within the same industry follow a uniform accounting approach for valuing their assets, then the market to book ratio is helpful when comparing their values. If the companies belong to different industries, the ratio may not accurately show their value differences. This is because some companies may record the original value of their assets on the balance sheet, whereas others record their assets at market value.
Calculating the book value of an asset or a business
Calculating the book value requires referring to the company's balance sheet. The balance sheet contains the assets section, which includes the sum of their depreciation, and the liabilities section. Obtaining the book value involves adding up these figures and calculating the difference. When calculating the book value of an asset, investors consider its useful life and whether it's depreciable.
An asset typically has a set depreciation period, which means a company has a limited time to write off the depreciation costs. If the company owns the asset long enough, its book value may only represent its scrap or salvage value. The salvage value is the amount the business expects to receive for selling the asset at the end of its useful life. If an asset isn't depreciable or doesn't have a limited useful life, such as land, investors amortize it and factor it into its value on the balance sheet.
Why is the book value important?
The book value is important for businesses and industries that depend on tangible assets, as it shows an accurate picture of the company's worth. It can also give an idea of the financial state of the business and its potential as an investment. Investors can also find good deals on undervalued stocks or stocks that have the potential to grow and increase in price.
Formulas for calculating the book value with examples
Here are three commonly used book value formulas:
The value of the total assets is the sum of the company's current and non-current assets, while the total liabilities are the sum of the current and non-current liabilities. This formula shows how to calculate the book value of a company:
Book value of a company = total assets − total liabilities
For example, a company recorded its total assets as $225,000 and its total liabilities as $105,000. The company's accountant calculated the book value as:
Book value = $225,000 − $105,000
Book value = $120,000
The book value of the company on its balance sheet is $120,000.
This formula shows how to calculate the book value of an asset:
Book value of an asset = total cost − depreciation
For example, a publishing house recently purchased a printer for $500 and estimated its depreciation at $100 per year. To determine its book value at the end of the second year, its accountant performed the following calculation:
Book value = $500 − ($100 × 2)
Book value = $500 − $200
Book value = $300
The book value recorded on the business's balance sheet at the end of the second year was $300.
Outstanding shares refer to the company's stocks that shareholders have purchased and are presently holding. This formula shows how to calculate the book value per share (BVPS):
BVPS = (shareholders' equity − preferred stock) / average shares outstanding
For example, a company has total assets of $400,000 and total liabilities of $250,000. It also has preferred stocks of $30,000 and average shares outstanding of $40,000. Here is how the company calculates its BVPS:
BVPS = [($400,000 − $250,000) − $30,000] / $40,000
BVPS = $150,000 − $30,000 / $40,000
BVPS = $3
The company's book value for every share is $3.
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