Book value of Equity can define as the company’s common equity, which is simply the amount that is available to be distributed within the shareholders.
It is the net amount of the total assets of the firm, after all the liabilities have been subsequently paid off.
Therefore, is can simply be described as the amount that the shareholders of the company are entitled to, after all debts, and relevant obligations have been paid off.
Components of Book Value of Equity:
The Book Value of Equity has four major components, which include the owners’ contribution, retained earnings, Other Comprehensive Income, as well as treasury shares that are purchased by the company. These components are further described in detail below:
Owners’ contribution are the funds that are directly paid by the owners (the shareholders) of the company to the company.
This includes the equity that is issued at the par value of the shares, as well as the additional paid-in capital that is paid over and above the par value of the shares that are issued.
Therefore, Owners’ contribution can be described as the summation of the common stock that is issued at par, and the additional paid in capital that has been raised by the company.
Retained Earnings are cumulative earnings that have been aggregated over the course of time by the company.
As a matter of fact, it can be seen that retained earnings are simply profits that the company has not yet distributed in the form of dividends to the shareholders, but have retained them with themselves for some reason (expansion, for example).
This accumulated figure is technically owned by the shareholders of the company, and hence, this is also included when calculating the Book Value of Equity.
Other Comprehensive Income
Other Comprehensive Income can be described as the net income in accordance with the profit and loss statement that is created.
This accumulated figure represents the Other Comprehensive Income that has been earned and retained by the company over the course of time.
Treasury Shares are the shares that the company has bought back from the existing shareholders. As opposed to cancelling those shares altogether, the company prefers to hold those shares, and represent them as treasury shares in the books of the company.
Book Value of Equity can be defined as the summation of the following components:
Book Value of Equity = Shareholder’s Equity + Retained Earnings + Other Comprehensive Income + Treasury Shares
How to Calculate?
Book Value of Equity is simply calculated by calculating the net figures of all the categories. They can either be readily available from the financial statements of the company, particularly the Balance Sheet (also referred to as Statement of Financial Position).
Using the figures for all the categories mentioned, the Book Value of Equity is subsequently calculated, as shown in the example below.
Examples and Solutions
Feliz Inc. has the following Balance Sheet extract at the end of the Fiscal Year 2019.
|Common Stock||$ 150,000|
|Retained Earnings||$ 74,000|
|Other Comprehensive Income||$ 34,000|
|Treasury Shares||$ 18,000|
Given the Balance Sheet extract, as shown above, Book Value of Equity can be calculated in the following manner:
Book Value of Equity=Shareholder’s Equity + Retained Earnings + Other Comprehensive Income + Treasury Shares
Book Value of Equity=$150,000+74,000+34,000+18,000
Book Value of Equity=$276,000
Book Value of Equity can be defined as a very important metric that is helpful for the company because of a number of reasons.
Firstly, it helps to draw a comparative analysis with the actual prevalent share price of the company. For example, in the case above, the Book Value of Equity is $276,000.
Supposing, there are 10,000 shares issued, it would mean that the Book Value of Equity / Issued share would be $27.6. In the case where the share is valued at $30 in the market, the share would be considered as over-valued.
On the contrary, if it is priced and trading at $25, it would be considered as undervalued. This metric is very important to understand valuation related dynamics within the company.
In the same manner, book value of equity is also an important phenomenon because of the fact that it is indicative of the financial health of the company.
Over the course of time, if the book value of equity within the company increases, it is a sign of positivity.
On the other hand, a reducing book value of equity would be an alarming sign for the company’s decision makers, as well as the investors.
However, there are a couple of drawbacks of this particular metric too. Firstly, it can be seen that on the Balance Sheet, the Non-Current Assets are maintained at their historical price.
However, prices of those assets are likely to fluctuate with time, because of which the real or the actual market value of those assets might not always be included in the analysis.
In the same manner, it does not always include intangible assets in the calculation, because of which the amount of Book Value of Equity might not be a very accurate representation of the inherent position of the company.