What is Book Value?
Book value or carrying value is the net worth of an asset that is recorded on the balance sheet. Book value is calculated by subtracting any accumulated depreciation from an asset’s purchase price or historical cost.
In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company’s book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be “tangible book value”.
What Does Book Value Mean?
Essentially, an assets book value is the current value of the asset with respect to the asset’s useful life. In other words, the book value adjusts the historical cost of an asset by the accumulated depreciation.
Book value = Historical cost - Accumulated depreciation
Every year as depreciation is booked for an asset, the accumulated depreciation account is credited. As the accumulated depreciation account increases, the book value of the corresponding asset decreases.
The term ‘book value’ derives from the accounting practice of recording asset value at the original historical cost in the books. While the book value of an asset may stay the same over time by accounting measurements, the book value of a company collectively can grow from the accumulation of earnings generated through asset use. Since a company’s book value represents the shareholding worth, comparing book value with market value of the shares can serve as an effective valuation technique when trying to decide whether shares are fairly priced.
Book value is also known as “net book value” and, in the U.K., “net asset value”.
As the accounting value of a firm, book value has two main uses:
- It serves as the total value of the company’s assets that shareholders would theoretically receive if a company were liquidated.
- When compared to the company’s market value, book value can indicate whether a stock is under- or overpriced.
In personal finance, the book value of an investment is the price paid for a security or debt investment. When a company sells stock, the selling price minus the book value is the capital gain or loss from the investment.
Two Types of Book Value
When using ‘book value’ in discussing a business, this refers to the total amount that the business is worth after all liabilities are paid off, and the total value of the intangible assets is subtracted from that of the tangible assets. The result is the book value of the business.
Book value can also refer specifically to assets held by a company. In this case, the book value of the asset is the current value taking into account depreciation. This amount should be updated and reflected in the company’s balance sheet.
Importance of Book Value
Book value is considered important in terms of valuation because it represents a fair and accurate picture of a company’s worth. The figure is determined using factual company data and isn’t typically a subjective figure. This means that investors and market analysts get a reasonable idea of the company’s actual worth.
Book value is primarily important for investors using a value investing strategy because it can enable them to find bargain deals on stocks, especially if they suspect that a company is undervalued and/or is poised to grow, and the stock is going to rise in price.
Stocks that trade below book value are often considered a steal because they are anticipated to turn around and trade higher. Investors who can grab the stocks while costs are low in relation to the company’s book value are in an ideal position to make a substantial profit and be in a good trading position down the road.
Pros and cons of book value
Pros of book value
Using the book value calculation can show how much a business or asset is worth based on data, rather than on speculation or opinion. Therefore, it is considered a relatively accurate measure of value. This means it can be useful when trying to learn more about a company or find stocks at a fair price.
Cons of book value
Book value alone is not a definitive measure of value. This is because book value is ineffective at valuing intangible assets, such as intellectual property rights. For example, companies that develop software might be able to develop products for a relatively low cost, so the balance sheet might not reflect the true value of the assets. This could mean that the company’s shares trade at many times their book value but should not be considered overvalued.
Book value should therefore be used as a comparative measure (to compare assets and companies with one another).