Book value may be defined as present or depreciated financial worth of the property. It is determined by historical costs and the accounting estimate which is based on the criterion of acquisition costs and the cost of production.
The value of major securities that are in the business’ accounting is estimated by the number of securities and their nominal value adjusted for any premiums or discounts and the amount of their depreciation. When talking about shares, it also includes the amount of retained earnings and the amount of any backups.
Asset book value
The book value of an asset is the cost of an asset at the moment of buying. That value is decreased over time because of depreciation, depletion and amortization. These processes are diminishing the initial value of an asset and they are considered to be company’s costs. Supplies and consumables are not assets, but rather expenses.
The main advantage
The main advantage of this concept is the value of the objectivity its foundation has. Due to the inactivity and historical conservatism, it is not the most suitable for determining fair or intrinsic value.
The difference between book value and market value
While book value represents pure, theoretical worth of a company according to its financial reports, market value is determined by the stock market. Talking about the value of a company usually means referring to its market value.
The relationship between these two values can be represented like this:
- Book value is higher than market value – it means that the market doesn’t believe that the company is worth the amount that is book value.
- Book value is lower than market value – this case happens when the market sees the potential in the company and it’s usually the case with constantly profitable companies.
- These two values are equal – the market doesn’t have motives to estimate higher or lower price of the company than stated in the books.
Their relationship is important because they pretty much depend on each other. In fact, there is a formula determining what is called the price-to-book ratio and it looks like this:
Price to book ratio = share price / (shareholders equity/number of shares outstanding)
When book value and market value are equal, the result of the above equation is 1. Anything less than 1 means that the book value is higher, and any result above 1 means that the market value is higher.