As a business owner, you have many types of assets. Knowing how much your assets are worth is necessary for properly creating financial statements, obtaining outside financing, and selling your property.
But, assets don’t retain the same value throughout their life cycle. You need to know the difference between book value vs. market value to know the accurate worth of your business and its assets.
Book value vs. market value
In business, you must know each asset’s book value and market value. Although both values are important in business, knowing the difference between book value and market value is necessary for decision making and recordkeeping.
Book value is the amount you paid for an asset minus depreciation, or an asset’s reduced value due to time. Also known as net book value or carrying value, book value is used on your business’s balance sheet under the equity section.
For example, you purchase a car. At the end of the year, the car loses value due to depreciation. Its book value is its original cost minus depreciation.
When you purchase an asset, you must record it at its book value in your small business accounting books. And, be sure to create journal entries showing the amount of depreciation.
Book value can also refer to the worth of your company as a whole, known as net asset value. Your business’s net asset value is calculated by subtracting liabilities and intangible assets from total assets.
Your business’s book value shows you how much your company should be worth, in theory, if you were to liquidate your assets.
However, book value should be taken with a grain of salt. The value of assets changes depending on the market. You will need to know your assets’ or business’s market value if you are ready to sell.
Market value, also called fair value, is what an asset would sell for in the current market. The market value of an asset is usually different than its book value, depending on whether the asset is increasing or decreasing in value.
Let’s say you purchase a car. Its market value is how much you would receive for it if you were to sell it right now.
Although an asset’s book value is recorded on the balance sheet for small business, you also need to know its market value. This is the amount you or investors would actually receive if you were to sell an asset.
Market value also refers to the actual worth of your business. It shows how much you would receive if you were to liquidate your assets in the current market.
Book vs. market value: which is greater?
Most business owners want to know whether the book value vs. fair value of an asset or their business is higher. Your asset’s value depends on the type of property it is and the current market.
Here are three possible options when gauging your asset’s value:
- The asset’s book value is higher than its market value
- The asset’s book value is lower than its market value
- The asset’s book value is equal to its market value
Keep in mind that the market value of an asset could change for better or worse during the course of its useful life. Like the stock market, where the value of stocks is always changing, the market value of your assets and business could be higher than what you paid one day and lower the next.
Book value is higher than market value
In the case of many assets, its book value is higher than market value. This means your asset would sell for less than the price you originally paid for it minus depreciation.
Let’s say you wanted to sell a car. You originally paid $15,000 for it and recorded depreciation of $2,000. But when you go to sell it, it is only worth $7,000 in the market. Your car’s book value minus depreciation is greater than its market value.
The book value of your company might also be higher than its market value. The amount of money you put into your company may outweigh its worth in the current market.
Market value is higher than book value
Some assets might have a higher market value than book value, meaning it would sell for more than what you paid for it minus depreciation.
For example, you bought a machine for $7,000 and recorded $1,500 for depreciation. Its book value is $5,500, but it would sell for $6,000. Its market value is higher than its book value, resulting in a gain for your business.
When your company has a higher market value than book value, it typically means your business is profitable and will continue to grow.
Book value is equal to market value
Sometimes, an asset’s book value is equal to its market value. This means the market sees your asset as being worth no more or less than what you paid for it minus depreciation.
Let’s say an asset has a book value of $2,000. The market also values the asset at $2,000. You don’t gain or lose from selling the property.
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This article is updated from its original publication date of July 3, 2018.This is not intended as legal advice; for more information, please click here.