The concepts of market value and book value are incredibly simple, and many businesses use this critical difference to their advantage for every situation imaginable. The misuse of either value can give people a different impression of the company in question, usually leading to lower taxes and higher share value. When evaluating any investment using a balance sheet, it’s crucial to note which value the company uses; it’s the difference between a great investment and a loss.
Book value is the analytical term for the total value of a business, using the numbers on its balance sheet. This is the difference between a companies total expenditures, such as for stock and staffing, and the companies total income. A hypothetical example, say business ‘B’, has £10 million in assets and £4 million in liabilities. Now, if ‘B’ chose to liquidate all of its assets, such as property, stock, and machinery, then there would be £6 million left over (net worth). This £6 million is the book value of company ‘B’. Now this remaining money would be split across shareholders; 1000 total shares means that each share would be worth £6 thousand. Book value is used to gauge shareholder equity, but is a mostly hypothetical value, as its rare that this scenario happens to a business.
Market value is related to this, but can often be wildly different. This is the figure often used by newspapers and investors when talking about a company; the actual value of each stock on the stock market. The reason these two values differ more often that not is down to many factors. The industry the company is part of being a major one; some companies have a shorter lifespan than others, and assets cannot be easily liquidate for some stock. The nature of a companies liabilities also play into this, with some companies simply owing too much to be paid in time; even if investors could levy this until a company had been liquidated, the interest may make it unreasonable.
When talking about assets there is a slightly different definition for each value; the book value is what was originally paid, and market value is what the item would be worth at market currently. This is commonly found when a business goes bankrupt; liquidation of property at the price paid for (book value) while gaining the market value. For instance, if a company owned a warehouse for 30 years, and the value had increased, liquidation may only get a small percentage of the actual value.
Many unscrupulous companies may choose which figures to update or not, and without thorough due-diligence, it can be unclear if an investment is using its book value or market value. Many entrepreneurial ventures make their value look increased by choosing when to record their finances; by accepting payment on a service without immediate expenditure it can appear a company to be doing well. This type of market manipulation almost always leads to a loss in confidence in an investment at market, and leads to a lower-than-book market value. If this has happened to a company, it’s likely not a good investment, and should be avoided.