Book Value vs Market Value

The concept of book value and market value are very different in nature even though they both attempt to estimate how much an asset or a business is worth.

These concepts approach valuations from different perspectives as the book value uses historical information to determine the value of the asset while the market value assesses how much the market would be willing to pay for it.

Throughout the following article we will outline the most important differences between both concepts and how they are usually applied and used in the business world.

What is Book Value?

The book value of an asset reflects how much the asset is worth based on the price paid for the asset back when it was purchased minus any accumulated depreciation. On the other hand, this concept also refers to the value of a company’s Shareholder’s Equity as measured by accounting records.

The book value doesn’t necessarily reflect how much an asset is worth if it were to be sold as it only takes into account the historical value of it. If the asset is sold at a price higher than its book value, the organization would register a process as a result of the transaction and the opposite is also true if the asset is sold at a price lower than its book value, as in that case a loss would be registered.

What is Market Value?

The market value of an asset is an estimation of how much a willing buyer would pay for the asset as is. This approximation is based on available market information such as the price recently paid for other similar assets and it is a more reliable measure of an asset’s worth compared to its book value.

From an accounting perspective, the market value of an asset can’t always be reflected on the company’s books, especially when it comes to fixed assets, as certain accounting principles prevent that companies continually revalue their assets.

Key Takeaways

Key Differences Between Book Value and Market Value

What do Each Measure?

The book value of an asset or a business measures how much they are worth purely based on accounting records. This means that individual assets will be valued based on their historical price minus any accumulated depreciation and the same goes for the company’s debt.

The market value, on the other hand, measures how much a buyer would be willing to pay for the asset or the business in its current state and both values can be considerably different under certain circumstances.

What is the bases for each measurement – historical cost vs trending FMV of the asset

The first step to calculate the book value of an asset is to determine how much it cost to purchase it. This not only includes the price paid for the asset, but also any other expenses associated with its installation and transportation to the place where it is supposed to be used.

After that, accountants have to estimate the useful life of each asset based on certain guidelines and they also have to determine if the asset will be assigned with a residual value.

Finally, as time passes, the book value of the asset will be progressively diminished by depreciation charges applied to it and the book value can be calculated at any given point in time simply by deducting the accumulated depreciation minus the historical cost of the asset.

From the perspective of an entire business, on the other hand, the book value of a company can be estimated as its total assets minus its total liabilities.

The market value on the other hand cannot be calculated. Instead, it is determined by using primary and secondary sources of information such as quotations from the supplier of the asset or by researching any recent transaction involving a similar asset to use the price paid on that operation as a reference.

When it comes to a publicly traded business, the market value of its equity is determine by market forces and it is updated by the minute on the exchange that the business shares are traded.

Frequency of Valuation Fluctuations

The book value of an asset rarely fluctuates as it usually remains unchanged within the company’s books. On the other hand, there are certain instances in which the book value of an asset can be revalued based on extreme changes in market conditions or changes in the asset itself.

The book value of a business as a whole will probably fluctuate over time depending on whether the business is generating profits or losses or if new capital is invested on it.

In contrast, the market value of an asset or a business can fluctuate significantly even during a short period of time, as this value is determined based by market forces. It can be concluded, then, that market values are considerably more volatile than book values.

Book Value and Market Value Examples

United Logistics is a company that operates various warehouses and it provides order fulfillment services to e-commerce businesses based in the United States and abroad. The company’s most important assets are transportation vehicles, warehouse equipment, and automated machinery that helps them in fulfilling each order received in record time.

The company is currently looking to sell some old forklifts to renew the fleet and the CEO of the business approached the accounting department to determine how much he could sell them for.

Each forklift cost $18,000 and they were assigned with 4 years of useful life each. Additionally, no residual value was recorded for the forklifts, which means that the annual depreciation charge would be $4,500.

These forklifts have 3 years of age and based on the information given by the accounting department their current book value is $4,500 ($18,000 – ($4,500 * 3)).

On the other hand, after approaching some intermediaries the CEO found that these forklifts could be sold for $3,800 as the market for used forklifts doesn’t have that much demand.

In this case, the book value of the forklifts ($4,500) is different than its market value ($3,800).

Bottom Line

The book value and market value of an asset or a business can vary significantly and they are not necessarily related as the former is determined by using historical costs while the latter is determine by market forces based on the dynamics of supply and demand.

Frequently Asked Questions

What distinguishes book value from market value in financial analysis?

Book value represents the net asset value of a company according to its balance sheet, while market value reflects what investors are currently willing to pay for its shares or assets in the open market, often influenced by future growth prospects and market perceptions.

How can a company’s book value differ significantly from its market value?

A significant difference can arise due to factors such as investor sentiment, market conditions, and future earnings potential, where market value may greatly exceed book value in the case of high investor confidence and growth expectations, or fall below book value if the company is perceived to be in decline.

Why might investors consider both book value and market value when evaluating a stock?

Considering both values allows investors to assess a company’s underlying asset value compared to its valuation in the investor community, providing insights into potential overvaluation or undervaluation based on current market dynamics and fundamentals.

Can the book value of a company change over time, and how does this affect market value?

Yes, the book value can change due to factors like asset depreciation or acquisition, affecting the company’s net asset value; however, market value may not directly correlate with these changes and is more influenced by investor expectations and market trends.