Meaning and definition of Book Value
The book value can be defined as the value at which an asset is passed on a balance sheet. The book value is also referred as “Net Asset Value” in the UK.
As explained by Investopedia, the book value is the total value of a company’s assets which would be theoretically received by the shareholders on liquidation of a company. On being compared to the market value of the company, the book value can be a sign of the stock being over- or underpriced.
However, in personal finance, the book value of an investment refers to the price paid for a debt investment or a security. On the sale of a stock, the capital gain or loss is calculated by deducting the selling price from the book value.
Calculating the Book Value of an Asset
To calculate the book value of an asset, the accumulated depreciation is deducted from the cost of the asset.
The calculation of net asset value of a company involves a deduction of intangible assets, like patents and goodwill, and the liabilities from the total assets.
Importance of Book Value
It has been proved by various studies that book value is the most effective evaluation in determining the performance of stock. The book value method is generally used as a technique of cross-testing the more common method of applying multiples to cash flow, EBIT, or net earnings. The use of book value is, however, the primary method of valuation in the following mentioned situations:
- Where the company is noticed to lose money on an operating basis. In such situations, there are no earnings on which the aforesaid multiples can be applied. Thus, the book value of assets is used for valuation in such cases.
- Book value holds great importance for quantifying assets in small distribution companies with sales below $20 million. The distributors of this category are generally successful due to the close relationships between departing owners and the company’s customers and suppliers. These relationships are questionable for these are generally non transferable and non contractual. Such companies, most commonly, offer sales at their book value in addition to a modest premium.