Book ValueDefined Along with Formula and How to Calculate it

Written By:
Lisa Borga

Book value is the net worth of an asset as it is recorded on the company’s balance sheet.

Book value is calculated by taking the original cost of the asset minus the assets accumulated depreciation.

Companies also have a book value, which is what the company would be worth to the stockholders after all of the assets were liquidated, and the debts paid.

This can be calculated by taking the total assets of the company minus its total liabilities.

The book value of a company is typically lower than the market value.

Computing Book Value

There are two different formulas that are frequently used for computing book value.

One is used to compute the book value of an asset, and the other is used to compute the book value of a company.

Book Value of an Asset = Original Cost of the Asset – Accumulated Depreciation

*Where accumulated depreciation is the total depreciation that has been recorded for an asset since its purchase.

As an example, let’s calculate the book value of a desk costing $7000:

$7,000 (original cost of the desk) – $2,000 (2 years of depreciation at $1,000/year) = $5,000 (book value)

Now let’s calculate the book value of a company using the following formula:

Book Value of a Company = Total Assets of the Company – Total Liabilities of the Company

We will use the book value of Tom’s Lawn Care Company as an example.

Tom’s Lawn Care Company has total assets of $150,000 and total liabilities of $30,000:

$150,000 (the total assets of the company) – $30,000 (the total liabilities of the company) = $120,000 (book value of the business)

What is Book Value

The phrase book value is a reference to the practice of recording an asset’s value at its original cost.

The book value of a company is actually the accounting value of the company’s assets.

It is possible for the book value of a company to remain the same for many years.

Although, the book value of a company can increase as assets are used, and earnings accumulate.

Book value can be used as a way to determine if the shares of stock had a fair price when compared to market value since the book value shows what the stock is worth to shareholders.

Uses of Book Value as an Accounting Value for a Company

There are two main uses of book value as an accounting value.

One of these uses is to tell if a stock is overpriced or underpriced.

The book value of a stock, in theory, shows what the stockholders would receive if the company were to be liquidated.

Because of this, the book value of a company can be compared to the market value of the company to determine if the stock is overvalued or undervalued.

Another use for book value as an accounting value is to compute a stock’s book value per share (BVPS).

The BVPS is the per-share book value of the company.

This value is computed based on the company’s common shareholders’ equity.

The book value per common share gives the dollar value per share that a common stockholder would receive if the company assets were liquidated and all debts were paid.

If the BVPS of a company is higher than the current market value of a share of the company’s stock, then the stock is undervalued.

Book value has a different meaning in personal finance.

It is the price that is paid for a debt investment or security.

Then, if a company sells the stock, the capital gain or loss on the investment can be determined by subtracting the book value from the selling price.

Limits on the Usefulness of Book Value

Book value does not always work as a good proxy for the market value of shares unless mark to market value is used on any assets that may increase or decrease in market value.

Examples of this are rare earth metals, which can increase in value over time, or computer equipment, which will decrease in value over time.

In either of these cases, relying on book value at the historical cost would not give an accurate indication of the actual value of these assets.

Price-to-Book Ratio

Price-to-book (P/B) ratio, when used as a valuation multiple, is a good way to compare the value of similar companies that operate in the same industry if they use a uniform accounting method when determining the present value of their assets.

In this situation, a high price to book ratio would indicate a premium valuation, and a low price to book ratio would indicate a discount valuation.

This ratio may not work as well if the companies being compared are in different industries or record the value of their assets differently, such as when one company records assets at market value, and the other company records assets at historical costs.