Book Value is the value of a single asset or a company as a whole in the balance sheet. For an asset, it is calculated as original value minus depreciation, amortization, or impairment.
For the whole company, it is total assets minus liability.
What can book value tell you?
Book value indicates how much each asset of your company costs at each separate moment of time. Using data from the bookkeeping records, it's not hard to calculate. Things depreciate as they age. When you put the amount by which an asset has depreciated plus wear-and-tear next to its original cost, you get a sum you could potentially earn by selling it right now.
Companies don’t get to deduct depreciation losses from their revenue, though. In the UK, a business gets to deduct them only once it replaces the asset. It is regulated by something called capital allowance. It is a sum that is spent on business assets that a company can deduct from its taxable revenue. In the 19/20 tax year, up to £1,000,000 in revenue can be tax-free.
The book value of the company’s stuff tells the book value of the company itself, once you deduct the company’s liability, like credit obligations. Public companies calculate their book value per share by simply dividing the sum by the number of shares they plan to issue.
Also, the book value helps to find the right moment to sell or to buy both assets and whole businesses. Measuring book value of something against its market price tells if it’s over/undervalued. Buy low, sell high!
Book value is also useful when talking to potential investors as it can help you make the case for investing in your company. In a 1934 book called Security Analysis by Benjamin Graham and David Dodd from Columbia Business School authors argued that looking at Price-to-Book ratio is an important metric when looking for a company worth investing in. For investors that share their approach called “value investing” (Warren Buffet among others), low Price-to-Book means that the company is undervalued. And if the business is good, the price will catch up. Making a case like that to the investors shows that their share will almost certainly increase in value over time.
If your business is not publicly traded, the book value is still helpful when dealing with investors as it gives a reference point when negotiating a price for a certain share of the company.
What it doesn’t tell
The book value doesn’t tell you the market value of intangible assets of your company. They simply remain as expenses in your books. In many cases, intangible assets are as valuable as tangible assets. If not even more.
For a software company, for example, often a feature that costs little to develop improves the app a lot, which makes the app worth significantly more than it used to be. But this asset is just an expense in the books.
Another issue is the assets that rise in value instead of depreciating. An example here can be vintage guitars. Fenders and Gibsons made in the ’60s are climbing up in value every year as they become harder to get. If you own a recording studio, they are your machinery that makes the product. Assets that make products normally depreciate, but not these ones.
To sum up:
- Book value tells you how much your business and/or its assets are worth at any given moment;
- Book value helps you make decisions to buy/sell when it is compared to the market price of an asset/company;
- Book value isn’t good with dealing with intangible assets;
- And it is flimsy when dealing with stuff that does not depreciate.