Updated July 10, 2023
Definition of Book Value of Equity
The book value of equity, also known as equity shareholders’ fund (common stock), represents the remaining funds available for distribution to equity shareholders.
It is derived by subtracting external liabilities, including preference shares, from the total assets. This value is typically presented on the balance sheet as a combination of equity share capital and the balance of reserves and surplus.
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, one can describe it as the amount that shareholders/residual owners have available for distribution after settling all existing liabilities. Generally, it is characterized by the company’s industry and management’s asset utilization efficiency. Investors generally look for it to compare it with its market price per share. Analysts consider the stock overvalued if the market price of the company’s share exceeds its book value per share. Conversely, experts regard the share as undervalued if the book value surpasses the market price per share.
Formula for Book Value of Equity
Depending upon available information, the Book Value of Equity (BVE) can be derived from any of the below-mentioned formulae: –
or
or
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
Example #1
As per the annual report of Samsung Inc., the company had a stockholders fund of $20,00,000, treasury shares of $5,00,000, retained earnings of $40,00,000, and other income of $5,00,000. Determine the book value of equity.
Solution:
The calculation for the book value of equity is as below:
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
- = $70,00,000
Example #2
Calculate Book Value per share from the below-mentioned details of M/s Orange Inc..
| Assets | Amount($) |
| 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:
We calculate the net asset value by summing all assets and then reducing it 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 |
The calculation for BVPS is as below:
- 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:
Based on the given information, one can conclude that investing in Jack Inc. is preferable over Orange Inc. because Jack Inc. has an undervalued stock, as its BVPS is lower than its market price. In contrast, Orange Inc. is overvalued. Over time, the price of Jack Inc. will increase to maintain price parity, while the price of Orange Inc. will decrease.
Recommendation: One should invest in Jack Inc.
Components of Book Value of Equity
- 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, 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 in 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: The company generates varied reserves and surpluses over time. For example – capital reserve, statutory reserve, allocated reserves for specific expenditures, 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 represents the trading value or price of a company’s equity shares on a stock exchange or other markets. It calculates a company’s market capitalization by multiplying the current stock price with the outstanding shares. The market value of equity fluctuates frequently based on market sentiments, enabling investors to assess the company’s operational scale.
Whereas book value is the shareholder’s equity, the amount of money payable to equity shareholders after the 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
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 generates 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
- 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 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 had been received earlier.
- It may not reveal a true and correct picture if balance sheet figures are window-dressed.
Conclusion
The 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 of the date and might lead to incorrect investment decisions.
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