Book value is the net value of a business’s assets. But because book value is based on historical value, it doesn’t reflect what you could actually get if you sold your tangible assets on the market.
That’s why you’ll need to understand book value limitations when making judgments about your enterprise value.
Accountants and business owners aren’t the only ones who use book value to understand a company’s financial state better. Lenders and investors use it, too — especially when deciding whether to extend credit or invest in a company.
Here’s what you need to know about book value as a small business owner.
What is the book value of an asset?
When we talk about book value relative to a fixed asset, it refers to the original cost of an asset minus any accumulated depreciation. Assets are recorded on the balance sheet, an essential financial document showing your company’s assets and liabilities.
Book value can represent the net value of a tangible asset, showcasing the amount all shareholders would receive if the company were liquidated.
One thing to remember: Your company’s total net value also includes intangible assets, such as your trademarks, copyrights, domains, and other types of intellectual property. Since these are valuable assets that your business spends money on to create and protect. These costs are capitalized and appear on the balance sheet, representing the value of intangible assets — and it’s also why they increase the book value of IP.
An example of book value of an asset in real-time
Your company, A-Plus Bakery, is doing so well that it’s time to bring in extra machinery to keep up with your customers’ demands. So, in 2022, you buy new equipment for $30,000. Your accountant records the value on your books as $30,000.
As your books are consistently updated and maintained, you’ll track the value of your company’s assets over time. To determine the value of your equipment after a year, you’d use a depreciation method to calculate the net the asset against its accumulated depreciation accurately. In this example, we will use the straight-line depreciation method.
Depreciation Expense = (Cost – Salvage value) / Useful life
Say that you calculate your equipment’s value using straight-line depreciation and find that it depreciates by $5,000 yearly. Two years later, your balance sheet will reflect the machinery at the original cost of $30,000 with accumulated depreciation of $10,000, resulting in a net asset value of $20,000.
Is book value the same as market value?
Book value is not the same as market value, so you can’t rely on market value to understand your company’s net asset values. Nor can you rely on book value to predict how much you might receive if you sell an asset.
That’s because book value refers to the value of an asset after it’s been adjusted for depreciation. Market value refers to the price someone will pay for an asset in the current market.
As you’re depreciating your fixed assets, we want to try to align the assets as close to market value as possible when you’re ready to sell. This is where the salvage value comes in. If you could sell that same machinery for $17,000 in 2026 we would adjust the depreciation calculation. Depreciation would be calculated as follows: (30,000 - 17,000)/4 years = $3,250 per year. By making this adjustment, in 2026 the asset value would be $17,000 and we would anticipate being able to sell the asset for that amount.
In short, book value might be more, less, or the same as the market price with the appropriate research and adjustments being made along the way. Keeping this distinction in mind when looking at your company’s balance sheets and making financial decisions about the future is crucial.
How book value affects your business as a whole
Book value can also be viewed as a reflection of a company’s net value of assets (NAV), which is your total assets minus total liabilities.
Since every company has assets, every company also has a book value. Typical assets include:
- Cash
- Cash equivalent
- Accounts receivable
- Inventory
- Vehicles
- Property
Let's say that all the equipment, vehicles, cash, and other things you can physically derive value from if you sold them — also known as your company's tangible assets and intangible assets, like intellectual property — have a grand total of $800,000. If your liabilities totaled $200,000, your company’s book value would be $600,000.
Think of the term book value as a metric that measures the total value of the company’s assets if the business is liquidated.
In other words, if you closed the doors on your business, how much money would be left if you sold off your assets and paid your debts? The leftover money would be considered the book value.
How to calculate book value
To find the book value, you’re looking at the value of a company based on its assets and liabilities — or the cost of each asset on the balance sheet.
Here are the book value formulas for assets and company value:
- Asset Book Value Formula
- To calculate the net book value of an asset, you start with the original cost and subtract accumulated depreciation.
- Net Book Value of an Asset = Total Cost of Asset – Accumulated Depreciation
- Company Value Book Formula
- When calculating the book value for the company, subtract total liabilities from the company’s total assets.
- Book Value of a Company = Net Total Assets – Total Company’s Liabilities
Using these formulas, you can learn more about how much your company’s assets should be valued.
Why book value matters — and what you can do with it
Book value helps understand your company’s value, even if it’s not the same as its market value. It gives you an idea of your company’s net asset value (which refers to assets compared to liabilities), but it also does much more. As a business owner, you can use your book value to do the following:
1. Be realistic about your business debt
Book value is a great way to understand how you fund your business.
If a business is funded mainly on debt, its book value will be very low. On the other hand, if you fund the business from the shareholders and operations, your book value will be higher because there is less debt in the company.
In short, knowing your book value lets you see net value on paper, so you’ll understand how your assets compare to your debts, accounts payable, and other liabilities.
2. Set financial performance benchmarks
Book value is a goalpost to strive for, especially if you are a small business owner.
You want your company’s balance sheet to reflect financial stability and ensure you can always appeal to lenders, investors, and shareholders’ equity. To do that, you need a positive book value.
You can also use book value to benchmark against competitors. This will help your company decide if they should make changes to improve financial performance.
Often, when businesses need to create a comparative benchmark analysis, they will start with the book value of a competitor and then normalize the financials to their own. Upon comparison of the two companies’ data, owners and executives may set goals on how to improve.
Comparing data that does not correlate can result in unattainable or unrealistic goals and expectations, which is why using book value as a comparison tool can be a critical metric for all companies.
A snapshot into normalizing adjustments
When creating a benchmark analysis, you first need to make normalizing adjustments. “Normalizing” in the accounting world refers to a company’s regular earnings — minus non-recurring charges and gains.
In other words, it should remove any unusual expenses or income unrelated to the business’s regular, day-to-day operations.
So, for example, if a dog grooming company took out a loan five years ago and was forgiven today, they would have to make normalizing adjustments since this is a one-time gain. Adjustments can also be made for discretionary expenses, like per-diem for employee travel.
Normalizing adjustments is essential because it affects your business book value. So when you’re analyzing historical financials and creating a comparative benchmark analysis, you’ll first want to perform normalizing adjustments to ensure that your income and cash flow are accurate.
Why does book value matter to lenders and investors?
A company’s book value is also essential for potential investors or lenders. Since fair market value is highly subjective based on what someone is willing to pay, it’s not a good indicator of the value of a company.
However, book value provides data that isn’t subjective because it represents a company’s historical data: As the asset depreciates, its value decreases. The total asset value then reflects these depreciation-adjusted values. This gives lenders and investors an accurate view of value.
While no single valuation method addresses all investment and comparative needs, book value can represent a historical measure of value. This added information can be invaluable to investors and lenders when deciding whether to invest or lend.
Enhance your financial clarity with automation
Book value lets you maintain a clear, objective view of your company’s finances. But to make the most out of it, you need automation to help you manage your accounting processes.
That’s where BILL can help
Staying on top of accounts payable is an important part of determining your book value. BILL can make this portion of your accounting easier to manage. You can spend 50% less time on your accounts payable process with BILL’s AP automation software.* Learn more about BILL today.
