Book Value – Definition and Usage
There are several definitions associated with the term ‘Book Value’ and depending on the context of its use, determines the correct definition and proper use. The three primary uses of the term are as follows:
- Stock, Corporate Value or Balance Sheet – simply stated as the equity value of a company divided by the number of shares held by investors. Most often refers to the total assets less intangibles in the asset section and less liabilities. Another way to think of this is to use the equity value on the balance sheet and subtract intangibles.
- Fixed Asset – when referring to a particular asset, it refers to the value on the balance sheet (books) which is traditionally calculated as purchase price less accumulated depreciation. On the flip side, book value is also used to provide the accounting value related to liabilities.
- Investment – the price plus fees for the purchase of stock or some other investment (security, bond, or insurance instrument).
From the above different uses, the reader would infer that the term is broad in scope and meaning. In reality, it is actually narrow in meaning. ‘Book Value’ is simply the accounting value of the particular asset. Or, it is the original value of the asset paid at the time of purchase less any utility consumed which is also another way of saying the accounting value. Any time the term is used, the statement made should include a reference to the particular use or category as identified above. Examples of setting the proper context include:
- A banker may ask the small business owner, ‘What is the book value of your business?’ Here the banker is referring the stock or corporate value.
- If an investor is comparing similar businesses in the same industry, he would want to know the book value of each business; in effect he is interested in the equity value for capitalization issues or possibly an indicator of working capital capacity.
- Sometimes an owner of a business is interested in knowing how much of a particular asset still sits on the books i.e. the net value (purchase price less accumulated depreciation). He may ask, ‘What is the book value of the truck?’ or ‘How much are my receivables worth?’ In both situations, the owner is trying to determine his financial position to determine a gain or loss upon sale or disposal of the particular asset.
- Any investment sold has a purchase price plus fees paid to acquire the investment. This is recorded as basis for the investment. When referring to investments such as stock, bonds or other commonly traded market securities, the book value is the price paid.
Remember, when this term is used, the term is a component of a statement referring to one of the three primary areas of business as identified above. Each of the sections below further elaborate on the definition and the proper context related to the three primary uses as identified above.
Stock, Corporate Value or Balance Sheet
The most commonly used version of book value relates to the context of the overall value of a company. This is frequently asked in reference to stock investments and analyzing businesses. The requester wants to know what is the accounting value (that which is recorded on the books) of a particular company. It is simple math:
The answer is no different when talking about a small business. How much equity is there in the company; in effect, what is the book value? Seems rather simple doesn’t it? Well, it gets a lot more complicated because there are many variations to the question and the associated answer. Let’s look at some of the variations:
Many companies, especially those with a few years of operations under their belts, have physical and nonphysical assets on the balance sheet. Nonphysical assets are referred to as intangibles. Intangibles can include copyrights, patents, and the purchase of goodwill. These types of assets are paper assets and not easily tradable nor is there much of a market for them. Often a requester of information wants to know ‘What is the tangible book value of the company?’ The key is that copyrights, patents, goodwill and other forms of intangible assets are usually amortized over time. Other types of paper assets such as cash, receivables, investments, prepaid expenses are not amortized and are included in the tangible calculation for this variation of book value.
When book value is used in reference to tangible book value, the answer is: ALL ASSETS LESS INTANGIBLES LESS LIABILITIES. Or a different method is to take EQUITY and subtract intangibles. To help you further understand this equation, please read How to Read the Balance Sheet – Simple Format.
Book Value per Share
Now let’s complicate the formula just a little further. In this variation, someone is not interested in the total company value, but is interested in what one single share of stock is worth on the books of the company. The answer isn’t hard to calculate, it is simply: Corporate Value divided by the number of shares sold. If a corporation is worth $283,200 and the owners have recorded 14,000 shares sold, the answer is $283,200 divided by 14,000 shares or $20.23 each.
Why would this be important? Well, in the publicly traded world, it is not uncommon for a share price on the open market to dip below the book value! It does happen. There are many factors that affect the publicly traded price and sometimes buyers shun a particular company due to risk. The stock price heads downward and there you go, it dips below the book value per share. This happens more frequently in the lower level markets such as the Over the Counter (OTC) markets and the Penny Stock Market.
But as a student of this term, you need to remember that when this variation is used, it is not uncommon for the information to be conveyed in full book value format and not in the tangible format. A more prudent investor would want to know: ‘What is the price per share based on tangible value? Do you see how this can have a significant bearing in an investor’s decision model?
This variation is used in the small business world in the legal documents between owners or shareholders. Several clauses in these agreements bind the owner’s to some form of compliance, sale or transfer of ownership, at a particular value. The most commonly used term is book value per share. For a small business owner, understanding its definition will help you to negotiate a better agreement between you and other parties.
Sometimes, when the requester is asking for the book value of the company, he is really interested in the accounting value in total and not necessarily on a per share basis. He may be looking at the working capital position of the business. Remember, working capital is current assets less current liabilities. In many small business operations the long term debt is similar in value as the fixed assets as often long term debt is used to purchase fixed assets. Therefore, the equity position of the small business is almost equal to the working capital. When a knowledgeable individual is looking for this kind of information they’ll follow up with the request for book value of current assets and the book value of the current liabilities. They may just ask for the current ratio. But the key to all this is how the question is asked.
In addition to how the question is asked, it is being asked under certain conditions such as investing in the business, possibly buying the business or to compare one similar business to another.
Remember, book value is merely the accounting value, that which is recorded to the financial statements, specifically the balance sheet.
The stock, corporate or balance sheet value is more of a macro level (total) book value. However, information may be sought at the group or single asset level for the company. In this situation, the information sought is designed to understand the accounting position of the particular group of assets or single line item on the balance sheet. I’ve often heard clients ask me for the book value of particular asset like a truck or the book value of receivables.
How is this calculated? The fastest method is to look at the balance sheet at the particular group of assets and use the accounting value provided. The best example is receivables. In general receivables are calculated as a sum of all the accounts added together less an estimated amount for bad debt. Thus the amount on the balance sheet assumes there will be some non-payment of what is owed to the business from regular customers. This is referred to as the book value. However, another term is proper – CARRYING VALUE.
Think of carrying value as a subset of book value. The term is specific to identifying the book value (accounting value) for a particular group of assets or a specific asset. In the business world, the proper use is to ask ‘What is the carrying value of the receivables?’ Or, ‘What is the carrying value of the forklift?’ Use carrying value when asking about the book value of a group of assets or a particular asset.
When asking about the carrying value or book value of a specific fixed asset, the reader may have to look at the respective schedules related to the group of assets in question to find the answer. Continuing with the forklift from above, within the grouping of equipment on the balance sheet is a schedule (usually a spreadsheet) that identifies the asset and the accumulated depreciation to date netting to accounting value on the books of record. The following is an example of this presentation format for warehouse equipment:
Balance Sheet Group: Equipment
Sub-Grouping: Warehouse Equipment
Item Acquisition Purchase Prior Current Accum Book
# Descrip Date Price Method Depreciation Deprec Deprec Balance
17 Ramp Sys 02/18/07 8,419 SL/7 4,310 1,203 5,513 2,906
51 Forklift 07/02/10 13,286 Modified SYD/5 2,744 2,122 4,866 8,420
82 Staging Sys 11/11/11 44,200 SL/7 1,052 6,314 7,366 36,834
From this report, the carrying value of the forklift is $8,420. Note something important here, the carrying value does not mean the fair market value. There is a big difference between book value (accounting value) and the fair market value for many assets in business. As a reader of financial statements, most of the current asset book values are fairly close to fair market value. Think of cash, it is exactly fair market value. However, receivables may not be as sometimes customers do not pay their bills, so there is risk there. But for most current assets, the risk is relatively low, for fixed assets such as warehouse equipment and more specifically the forklift, there is a large financial gap between the book balance (book value, carrying value) and the fair market value.
Not only are assets used with the term book value or carrying value, liabilities are also quantified on the books and the value is referred to as the book value. Often those involved in the bond industry will use the term carrying value and not book value. This is mostly out of tradition than recognition of the difference related to the terms book and carrying value. For your understanding, just remember, both book and carrying value refer to the accounting value on the books of record for the particular asset, group of assets, a liability or a group of liabilities.
On the personal level all of us have investments, some more than others. Investments range from purchase of stock to real estate. The most common term for investments is securities. These investments are most often found on our personal set of books and frequently are in the retirement accounts section of our personal assets. They are also found in business and are often located in the current assets section of the balance sheet.
This form of value is the most common discussion point between businessmen in general conversation. Mostly the focus is on performance (return) of a particular asset. To gauge the security’s return percentage, the requester of information needs to understand what was paid for the particular investment. A house flipper talking with another house flipper will ask ‘How much do you have in the property?’ – which is a polite way of asking for your book value in the investment.
When referring to investments and desiring to understand the book value, the correct term to use is BASIS. This term comes from the tax code and since investments are documented differently for tax purposes, the IRS separates these assets from others and uses the term of basis to identify the accounting value related to the particular investment. Unlike carrying value, most investments do not have depreciation or amortization associated with calculating the basis. This is not an absolute statement. When referring to real estate, there is often depreciation involved and so, therefore, you must adjust the purchase price by depreciation taken to date. There are some other investments that do adjust their purchase price by depreciation and/or amortization to determine the basis. But for the purpose of this article, I’m going to keep it simple and refer to investments as the more widely accepted definition of stocks, bonds, annuities, insurance instruments, and other publicly traded instruments commonly found on the stock exchanges.
Basis in an investment is calculated as the original purchase price paid plus any fees paid to acquire the investment. Common fees paid include broker fees, assessments, recording costs, and any interest paid to acquire the particular investment. There are a multitude of types of fees and the list can go on for a quite a few pages but in general they are some form of legal costs to have outright title to the investment. In addition to the original purchase price and fees, time related costs should be added to the investment to determine the actual book value (basis) of the investment. Examples of time related costs include interest on the investment if financed, taxes paid to maintain the investment, and even the annual brokerage maintenance fee prorated to your particular investment among all investments held by that broker. All of this is added together to calculate the current basis of your investment.
For sophisticated businesspersons, use the term BASIS when referring to investments if desiring to understand the book value (accounting value) of the investment.
There are many different mistakes made when using the term book value. Here are the most common (not in any particular order) and how to avoid making them:
- Some business operations refer to the client sales or portfolio of sales as having a book value. Examples of some businesses that do this include insurance and real estate brokerages. In effect they are really referring to the annual sales volume for the regular ongoing clients. This is generally not the proper use of the term book value. Book value is an accounting value related to some asset or liability on the official set of books. For these types of operations, they should refer to their respective sales sources as the potential portfolio value; that is the portfolio of clients/customers.
- Using the market value as the book value for an asset. This is really a big mistake because the definition of book value refers to the recorded transaction value (accounting) of the asset. The market value will fluctuate greatly in comparison to the book value. You can compare the market value with the book value, but do not substitute market value for book value.
- Another common error when using book value is to use the wrong balance sheet date. Why is this important? You see, the balance sheet changes every day and actually every time there is any sort of economic transaction in the business (typically hundreds of times per day). When discussing book value, the seeker of information is interested in knowing the accounting value at that very moment. Well, unless you have instant access to your books and you know your books are up to date, then the best answer is usually the most recent balance sheet value as it relates to the conclusion of the most recent accounting period. For most small businesses, it is the value at the end of the most recent quarter. For a lot of inquiries, the answer is based on the most recent fiscal year balance or calendar year balance. When answering the question, the value should be dated. That is, state the date of the balance sheet in determining the value. For our forklift example from above, you would answer the question with the following response: ‘The carrying value of the propane forklift as of 12/31/12 is $8,420’.
Summary – Book Value
Book value is simply the accounting value as stated on the balance sheet as of a given date. Book value has many different uses and based on the context of the conversation determines which version of the term is used. When discussing the value of the business or the value per share of a corporation, the proper term to use is book value. This is merely the total assets less liabilities which is also known as the equity of the business. However, it is not uncommon for the term to be defined as the tangible book value which is the equity of the business less the intangible assets (goodwill, patents, copyrights etc.).
When referring to a group of assets or a particular asset the proper term to use is carrying value which is a variation of book value. Again, just like book value in the aggregate, carrying value is the accounting value as stated on the balance sheet.
If you are interested in the book value of an investment, the best term to use is basis. Basis is the amount paid to date to have legal title or some form of rights to the respective security. Basis is a more refined level of the term book value. But in all cases, it is acceptable to use the term book value. However, I suggest that you should use the variation of the term based on the context of the conversation. This alerts others that you fully understand the term book value and how it should be used in conversation. More importantly, it moves you from being perceived as a novice businessman to a sophisticated entrepreneur.
Finally remember not to make the mistake of using fair market value or an aged balance sheet value when answering the question. Always answer the value question with a date identifier to let the listener know you understand what you are talking about. Act on Knowledge.
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