Determining the book value and the market value is crucial as it is a deciding factor for an investor to invest in a specific company.
The market price is a value the investor is ready to shell for a company’s stock. Understanding the calculation of the book value gives the investor a path to achieve financial goals.
Key Takeaways
- Book value is the value of an asset as recorded on a company’s balance sheet, while fair market value is the price that an asset would fetch on the open market.
- Book value is based on the historical cost of an asset and does not necessarily reflect its current market value. In contrast, supply and demand determine fair market value and are subject to fluctuations.
- Book value is used for accounting and tax purposes, while fair market value is used for valuing assets for sale or acquisition.
Book Value vs Market Value
Book value is the actual worth of a company’s wealth that changes periodically and is obtained by deducting the total liabilities from the total assets. Fair market value is the value of a property determined by objective purchasers and is the cost of any asset in the open market.
Book value is the actual worth of the wealth of the company. It changes on a periodic basis. We get the book value by reducing the total liabilities from the total assets.
The value of the assets gets liquidated immediately in the company. This amount gets distributed among the shareholders of the company.
Fair market value is when certain circumstances are met, an asset’s fair market value is the price it would sell for on the open market.
The state says that everyone must be aware of everything, know what they are doing in their own favorable interests, and have ample time to make their decision. Fair market value is used in tax settings and the real estate market.
Comparison Table
| Parameters Of Comparison | Book Value | Fair Market Value |
|---|---|---|
| Meaning | It is recorded in the book. | Fair Market value is the cost of any asset in the open market. |
| Reflect | Firm Equity | Asset value. |
| Fluctuation | Does not fluctuate, estimated periodically. | Frequently fluctuates. |
| Availability | It is readily available. | Sometimes readily ascertainable, and sometimes not. |
| Calculation | Tangible Assets | Depends on what buyer and seller agree on. |
What is Book Value?
Book value is the worth of the enterprise’s forte. It is the value found in the Balance Sheet. The shareholders consider this a rough value of the amount they would get when liquidated.
Book value helps the investor to determine the value per share while buying. Numerically the book value is the variance between the company’s gross forte and gross accountability.
For example, company ABC has total assets of 50 million and a total liability of 10 million. According to the company books, the valuation will be 40 million.
The company sells all the assets and pays the entire accountability. The book value of the company will be 20 million.
Total benefits comprise all economic points like money, short-term investment, amount to be received, and physical assets such as property, equipment, and plant.
Intangible assets like a brand name or any intellectual property listed in the financial statement could also be assets. The total liabilities include debts, payables, and deferred taxes.
Limitations of Book Value:
Book Value figures are reports either quarterly or annually. It might not help the investor grasp the changes over the months. Book valuation is an accounting terminology, and adjustments get made in the accounting statements.
Depreciation is the crucial adjustment made to assets. Grasping the accounting rules and practices related to depreciation could be difficult. Book value does not include the exact claims and the selling value. The intangible assets are difficult to assign worth.
What is Fair Market Value?
In general, fair market value is the cost of the venture asset would cost if it got set up in an unlocked or competitive marketplace.
It is a recurrent term used in the real estate trade. It is even a term used for tax negotiations in business ventures. It is concerned with amounting to an acceptable price for respective parties.
The insurance companies use the fair market value to decide a definite amount of assertion. It is not the same thing as market or appraised value. Fair market value gets used in legal expressions.
The Fair market value ponders the economic theories. Property tariffs are also accumulated by analyzing the Fair market value. It is the distinction between acquired power, and it depends on how long the owner owns the property.
Fair market value limitations
- It might result in high price swings that occur numerous times during the year: Some businesses do not benefit from this accounting system at all. These companies have assets that fluctuate significantly in value during the year. Volatile benefits can provide illusory gains or losses in the short term by reporting changes in revenue that aren’t accurate to the long-term financial picture.
- Misery, on the whole, enjoys company: If a single organization experiences a drop in net income due to asset losses, this can have a domino effect over a whole area or industry. Lower valuations are contagious because of the market’s volatility and frequently trigger unwarranted selling. When this kind of accounting isn’t used, and downward values aren’t required, more investor stability can help an area or industry’s overall performance.
Main Differences Between Book Value and Fair Market Value
- Book value is the accurate value of the assets of the company. Fair market value is the value of the benefits in the open market.
- Book value changes yearly in value. Fair market value fluctuates a lot.
- When book value is higher than market value, there is profit. When there is no pressure to sell, fair market value makes the amount set by the seller acceptable or not.
- For the calculation of book value, only tangible assets get considered. In fair market value, assets get included.
- Book value gets readily available. Fair market value is based on the price agreed by both parties.
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Piyush Yadav