How to calculate net book value

Written by dennis hobart
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How to calculate net book value
Investors use net book value to make sound financial decisions. (Jupiterimages/Goodshoot/Getty Images)

Net book value is a key figure for many investors. Since it's the closest estimate of the company's underlying value --- both what it paid for its assets and what it could get from selling them --- it often provides a "floor" for any other valuation. In addition, net book value tells investors what the company has invested to get whatever return it currently earns. Thus, net book value helps measure the efficiency of a business.

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Definition

Book value is the value of a company's assets, minus its liabilities. There are several variants on book value, but all of them encompass the value of a company's real estate, equipment, inventory, cash on hand and accounts receivable, as well as the size of the company's accounts payable, debt and taxes due. There are variations on book value depending on the exact nature of the calculation.

Defining Assets

To begin calculating book value, add up the total value of the company's assets. Assets are defined as anything that has value for the company. There are some assets that have an obvious value, such as cash on hand: It's worth 100 per cent of its face value. Other assets are harder to value. A manufacturer might have spent £0.6 million making a one-of-a-kind machine that no other company can use. If that machine produces £325,000 per year in profits, it's clearly quite valuable, but it can't be sold for anything near its real value. Accountants often create policies for valuing such complex assets.

Note the total value of these assets.

Defining Liabilities

Next calculate the company's total liabilities. Liabilities are anything that cause future cash outlays. If a company owes £32,500 to a supplier, that's a liability, as it will have to pay that amount eventually. Other liabilities are harder to value, though. If the company has been sued for £0.6 million, it's not a £0.6 million liability, as they may not have to pay. But it's not a £0 liability, as the company is worth less after being sued than it was before. Companies often adjust their liabilities for potential risks like these based on the likely outcome.

Note this number.

Intangible Assets and Liabilities

Decide how to handle intangible assets and liabilities. For many companies, the most valuable asset they own isn't tangible. A famous brand name such as Coca-Cola is worth billions of dollars, but it doesn't get added to a company's balance sheet. At the same time, pension liabilities can create a long-term cost for a company that's hard to estimate.

In general, you decide whether you're calculating worst-case or best-case scenarios. If you're considering the company's liquidation value, you should pay attention to only tangible assets, but to both tangible and intangible liabilities. If you're considering a company's highest possible future valuation, look at tangible and intangible assets, as well as discount intangible liabilities.

Adjust your total asset value and total liability value based on these intangible considerations.

Calculating Net Book Value

Subtract liabilities from assets. The result is the company's net book value. Use the guidance from previous sections to determine how to count difficult-to-measure assets and liabilities. This calculation takes into account everything of value the company owns, as well as all of its promises to other parties. The difference between these two numbers is what's left for the company's shareholders.

Check Your Work

To check your work, add the liabilities one at a time to the book value, until there are no liabilities left to add. The resulting number should be the company's assets, as calculated earlier. This is because net book value is equal to assets minus liabilities. Adding liabilities back to the equation leaves assets.

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