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.

We note from the above graph that Amazon's book value has been increasing over the past five years and is currently at $43.549 billion.

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 Stock is the equity capital at the par value of the shares, and the additional paid-in capital 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 shares are not canceled but rather held by the company as treasury shares 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 dividends. 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 income includes net income as per the profit and loss statement coupled with the accumulated other comprehensive income of the previous year.

It is calculated by adding the owner’s capital contribution, treasury shares, retained earnings, and accumulated other incomes. Mathematically, it is represented as,

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 report 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.

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.

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 assets because of its subjective nature of valuation.

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 sheet 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 Debt
• Book Value vs Market Value
• Formula of Book Value per Share
• Market to Book Ratio