The main objective of investing money is to gain profit and build a corpus. Thus it is reasonable for every investor to evaluate the company’s performance before investing their hard-earned money in it. But do you know how to evaluate the company’s performance? There are several ways to assess the company’s performance, like calculating profitability ratios or earnings per share (EPS). Out of these ways one such standard metric is book value, which is used to evaluate the value of the company’s assets. Read the article to know what book value is and how to calculate it.
What is book value?
You might have come across the term ‘book value’ while referring to a company’s financial status. But what is it? Let’s understand in depth. Book value is the company’s net asset value as recorded in its financial statements. In simple words, book value is the company’s total assets minus intangible assets and liabilities. This term originated from accounting parlance, where the balance sheet is often referred to as the company’s ‘books’ and is also referred to as the firm’s net asset value.
Herein, the company’s assets will include cash, certificates of deposit, investment, cost of a plant/ company, equipment, land, intellectual property, and more. While the company’s liabilities include debt, salaries, rent, mortgages, dividends payable, and more. As it is calculated using the total assets a company owns, a company that has significant physical assets will have a high book value.
How to calculate book value?
As mentioned earlier, book value is the difference between a company’s total assets and liabilities based on its balance sheet.
You can use the below formula to calculate the book value.
Book Value = Total Assets – Total Liabilities
However, if a company has intangible assets, they should also be considered in calculating the book value. Thus, you can use the below formula:
Book Value = Total Assets – (Intangible Assets + Total Liabilities)
Let’s understand this calculation with the help of an example.
As per the company’s financial records, X Co. has total assets of ₹ 5.5 crores, liabilities of ₹ 3.2 crores, and goodwill worth ₹1 crore. Now, let us calculate book value using the above formula.
Book Value = 5.5 – (3.2 + 1)
Book Value = ₹1.3 crores
What does book value indicate?
Now that you know how to calculate the book value, it’s time to understand what it indicates.
If a book value is low, then it is considered as the company’s stock is undervalued. On the other hand, if the book value is high, it is regarded as the company’s stock is overvalued. However, for making any investment decision, you must not rely solely on the book value; other parameters should also be considered, such as market value and price-to-earnings ratio (P/E).
Significance of book value
The below points will help you understand why book value is vital to a company.
- • It depicts a stock’s book value, which is the amount that shareholders will receive in case of liquidation.
- • Different companies’ performance can be compared through book value to know the potential of investment.
- • It can be compared with the company’s market value to assess whether the stock’s overpriced or underpriced.
- • It helps predict whether the stock has huge growth potential or whether investors will buy it in large volume. How?
- • In case the book value exceeds the market value, it can be inferred that the stock is undervalued and the market does not have confidence in it. Since the stock is undervalued, there are chances that investors will buy a larger volume.
- • If the book value is lesser than the market value, it can be considered as the stock is overvalued and the market has huge growth potential.
Limitations of book value
Following are the limitations associated with book value.
- • It considers only tangible assets leaving out intangible assets such as patents, trademarks, and copyrights.
- • It uses historical cost for pricing and doesn’t consider today’s inflation, forex, and market changes.
- • It is based on the company’s balance sheet, which is released either quarterly or annually; thus, evaluation of book value may not be relevant at the time of calculation.
Differences between book value and market value
Read on to understand the difference between book value and market value.
| Book Value | Market Value |
| Based on the balance sheet | Based on share price |
| Difference between the value of the assets and liabilities | Calculated by multiplying the market price of the share by the total number of shares outstanding |
| Depicts the actual value of the company’s assets | Informs the investor of the projected value of the company or its assets |
| Changes according to the release of the balance sheet more likely quarterly or annually | Changes every single moment |
Conclusion
Book value means company’s net asset value as recorded in its financial statements. It is evident from this article that the book value plays an important role in determining the company’s worth. However, along with the book value, you should also consider other parameters such as the price-to-book (P/B) ratio, price-to-earnings (P/E) ratio, EBITDA-to-sales ratio, and market capitalization before investing in any company.
