Definition of Book Value of Equity
Book value of equity, also commonly known as equity shareholders fund (common stock), can be defined as residual funds available for distribution to equity shareholders, i.e., net asset value derived as a total of all assets reduced by external liabilities, including preference share and is generally reflected under balance sheet in the form of equity share capital and reserves and surplus balance.
Explanation
The term book value of equity describes the value of money due to its shareholders in the form of share capital, reserves, and surplus after deducting all external claims. In other words, it can be described as the amount available for distribution among the shareholders/ residual owners after settling all existing liabilities. Generally, it is characterized by the company’s industry and its management’s asset utilization efficiency level. Investors generally look for the book equity value to compare it with its market price per share. The company’s stock is said to be overvalued if the market price of the company’s share is higher than its book value per share. On the other hand, the share is undervalued if its book value per share is more than the market price per share.
Formula for Book Value of Equity
Depending upon available information, Book Value of Equity (BVE) can be derived from any of the below-mentioned formulae: –
Book Value of Equity = Total Assets – Total External Liabilities
or
Book Value of Equity = Share Capital + Retained Earnings
or
Book Value of Equity = Owners Contribution + Treasury Shares + Retained Earnings + Accumulated Other Earnings
Here
- Total Assets = All current and non-current assets of the company.
- Total Liability = All external liabilities of the company.
- Share Capital = Shareholders’ capital contributed to capital or paid-up capital, equity capital.
- Retained Earnings = Portion of the business profits that have not been distributed to the shareholders.
- Contributed Surplus = Portion of shareholder’s equity reflecting the issuance of shares at a premium, i.e., above par value.
Examples of Book Value of Equity
Different examples are mentioned below:
Example #1
As per the annual report of Samsung Inc. the company had stockholders fund $20,00,000, treasury shares $5,00,000, retained earnings $40,00,000 and other income $5,00,000. Determine book value of equity.
Solution:
It is calculated as
Book Value of Equity = Owners Contribution + Treasury Shares + Retained Earnings + Accumulated Other Earnings
- Book Value of Equity = $20,00,000 + $5,00,000 + $40,00,000 + $5,00,000
- Book Value of Equity = $70,00,000
Example #2
From the below-mentioned details of M/s Orange Inc., calculate Book Value per share.
| Assets | Amount($) |
| Fixed Assets | 10,00,000 |
| Current Assets | 6,00,000 |
| Current liabilities | 4,00,000 |
| Long term Debts | 5,00,000 |
The total no. of outstanding shares is 1,00,000
Solution:
Net asset value will be calculated as the sum of all assets reduced by external liabilities, as follows:
| Assets | Amount($) |
| Fixed Assets | 10,00,000 |
| Current Assets | 6,00,000 |
| Total Assets | 16,00,000 |
| Less: – | |
| Current liabilities | 4,00,000 |
| Long term Debts | 5,00,000 |
| Net Assets | 7,00,000 |
| Equity Shareholders fund | 7,00,000 |
| No. of Shares | 1,00,000 |
BVPS is calculated as
BVPS = Equity Shareholders Fund / No. of Shares
- BVPS = 7,00,000 / 1,00,000
- BVPS = 7
Example #3
Compare and analyze the below-mentioned MPS and BVPS and recommend investment options:
| Company | BVPS | MPS |
| Orange | 1000 | 1200 |
| Jack | 500 | 440 |
Solution:
From the details mentioned above, one can conclude that it is better to invest in Jack Inc. instead of Orange Inc. because Orange’s BVPS is lower than its market price, i.e., the stock is overvalued. In contrast, it is undervalued in the case of Jack Inc. Over time, to maintain price parity, the price of Jack will increase, and orange will decrease.
Recommendation: One should invest in Jack Inc.
Components of Book Value of Equity
Different components are mentioned below:
- Capital Contributed by the Owners: Initial amount introduced by owners for the company. It is commonly known as a common stockholder’s equity capital. It provides very useful information when analyzing financial statements.
- Treasury Stock: Treasury stock, also known as repurchase stock, is the outstanding stock bought back by the issuing company from the shareholders. This results in a decrease in outstanding open shares from the market. These shares are issued but not outstanding and hence are not included for dividend distribution or in calculating earnings per share. As a result, Treasury stock is a contra equity account, reducing the balance sheet’s total equity value.
- Retained Earnings: The balance of profits retained in business after payment of dividends to its shareholders. Retained earnings can have a positive or negative balance. If the business is earning profits, its retained earnings will have a positive balance, while if it is incurring losses, retained earnings might have a negative balance.
- Miscellaneous Reserves: varied reserves and surplus are generated by the company over time. For example – capital reserve, statutory reserve, allocated reserves for specific expenditure, etc. All these reserves also form part of the equity shareholders’ fund.
Book Value of Equity vs Market Value of Equity
The market value of equity can be defined as the value or price at which a company’s equity shares are traded in a stock exchange or other markets. This concept is used in the determination of a company’s market capitalization. Market capitalization can be calculated by multiplying the current price of a stock with the number of outstanding shares. The market value equity always keeps changing frequently depending upon market sentiments. Therefore, it helps the investors determine the company’s operating size.
Whereas book value is the shareholder’s equity, the amount of money payable to equity shareholders after settlement of all external claims. At the same time, the book equity value is derived based on accounting records. Market value is driven by multiple factors like market sentiments, a company’s brand value, book profits, etc. An investor uses both concepts simultaneously for comparing, analyzing, and making investment decisions accordingly.
Benefits
Some of the benefits are given below:
It is an indicator of a company’s operating efficiency and financial strength. Investors apply this concept in analyzing, understanding, and deciding on investment action. A strong shareholders fund suggests that the company is generating considerable profits, whereas a negative value suggests weak operating efficiency and financial position. It helps determine whether the company’s share market price is overvalued or undervalued. In case of liquidation, it also provides information to owners regarding the final amount which will be received from the company.
Disadvantages
Some of the disadvantages are given below:
- Valuation of assets is carried on the historical value until it is revalued and is typically lower than the market value and results in understating the book value of equity.
- Book value is the part of quarterly, half-yearly, or annual filled annual reports and takes time to be published; as a result, the investor gets the information after a significant time of happening of the actual event, which might not be as useful if it would have been received earlier.
- It may not reveal a true and correct picture if balance sheet figures are window-dressed.
Conclusion
Book value of equity is the total amount due to a company’s shareholders. This is calculated as a difference between total assets and total external liabilities. BVE have got different implications and uses for different stakeholders. It denotes the actual amount that a shareholder will receive at liquidation. However, as it uses historical data for calculation, data might not reflect the actual position as on date and might lead to incorrect investment decisions.
Recommended Articles
This is a guide to Book Value of Equity. Here we also discuss the definition and components of the book value of equity and its benefits and disadvantages. You may also have a look at the following articles to learn more –
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