What is Book Value of Equity?

The term “Book Value of Equity” refers to a firm’s or company’s common equity, which is the amount available that can be distributed among the shareholders. It is equal to the amount of assets shareholders own outright after all the liabilities have been paid off.

Generally, the owner’s equity of a company is influenced by the industry in which it operates and how well it can manage its assets and liabilities. In fact, as a thumb rule, companies that are likely to perform well and generate higher profits are the ones that have a book value that is lower than their market value.

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Components

The book value of equity can be broken down into four major components: the owner’s contribution, Treasury shares, Retained earnings, and Other comprehensive income. Now, let us have a look at each of the components separately:

#1 – Owners Contribution (Common Stock & Additional Paid in Capital)

Common StockCommon StockCommon stocks are the number of shares of a company and are found in the balance sheet. It is calculated by subtracting retained earnings from total equity.read more is the equity capital at the par value of the sharesPar Value Of The SharesPar value of shares is the minimum share value determined by the company issuing such shares to the public. Companies will not sell such shares to the public for less than the decided value.read more, and the additional paid-in capitalAdditional Paid-in CapitalAdditional paid-in capital or capital surplus is the company’s excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market.read more is the excess capital over and above the par value.

#2 – Treasury Shares

At times companies buy back some floating shares as part of corporate strategy. These repurchased sharesRepurchased SharesShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.read more are not canceled but rather held by the company as treasury sharesTreasury SharesTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired. Moreover, it is not considered while calculating the Company’s Earnings Per Share or dividends. read more in their books.

#3 – Retained Earnings

It is the portion of the company profit not paid off to the company’s shareholders in the form of dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more. It is accumulated over a while if the company performs well and forms part of the shareholder’s equity.

#4 – Other Comprehensive Income

Other comprehensive incomeOther Comprehensive IncomeOther comprehensive income refers to income, expenses, revenue, or loss not being realized while preparing the company’s financial statements during an accounting period. Thus, it is excluded and shown after the net income.read more includes net income as per the profit and loss statement coupled with the accumulated other comprehensive income of the previous year.

Book Value of Equity Formula

It is calculated by adding the owner’s capital contribution, treasury shares, retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more, and accumulated other incomes. Mathematically, it is represented as,

Examples of Book Value of Equity Calculations (with Excel Template)

Example #1

Let us take the example of a company named RSZ Ltd. As per the recent annual report published by the company, the following financial information is available to us. Do the calculation of the book value of equity of the company based on the given information.

Based on the above formula, calculation of Book value of Equity of RSZ Ltd can be done as,

  • = $5,000,000 + $200,000 + $3,000,000 + $700,000= $8,900,000

Therefore, the company’s common equity is $8,900,000 as of the balance sheet date.

Example #2

To understand the concept of the firm’s common equity, let us take a practical example of Apple Inc.’s annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more published on September 29, 2018. Do the calculation of the book value of equity of Apple Inc. as of September 29, 2018. The following information was available:

Based on the above formula, the calculation can be done as,

  • = $40,201 Mn + $0 + $70,400 Mn + ($3,454 Mn)= $1,07,147 Mn

Therefore, as of September 29, 2018, Apple Inc.’s book value stood at $1,07,147 Mn.

Advantages

Now, let us have a look at the advantages of a Book Value:

  • It helps determine whether a stock is undervalued or overvalued by comparing it with the market price.It indicates a company’s financial health, i.e., a positive value indicates a healthy company. In contrast, a negative or declining value signals weak financial health.

Disadvantages

Now, let us have a look at the disadvantages of a Book Value:

  • Usually, the assets are carried at historical value unless revalued, which is typically lower than the market value and eventually understates the book value.Book value reports as part of the quarterly or annual filing. But the filings take time to publish, and as such, an investor comes to know about the book value of a company after a significant amount of time from the actual event.It fails to capture the impact of intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can’t touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more because of its subjective nature of valuation.

Conclusion

Book value of equity is an important concept because it helps interpret the financial health of a company or firm as it is the fair value of the residual assets after all the liabilities are paid off. From the perspective of an analyst or investor, it is all the better if the company’s balance sheetBalance Sheet Of The CompanyA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more is marked to market, i.e., it captures the most current market value of the assets and liabilities.

This article has been a guide to what is Book Value of Equity is. Here we discuss how to calculate the book value of equity along with its formula, examples, & Excel template. You can learn more about accounting from the following articles –

  • Book Value of DebtBook Value vs Market ValueFormula of Book Value per ShareMarket to Book Ratio