What is a Net Book Value?
Net book value refers to the net value or the carrying value of the assets of the company as per its books of account, which is reported on the company’s balance sheet, and it is calculated by subtracting the accumulated depreciation from the original purchase price of the asset of the company.
Net Book Value Formula
The formula used to calculate the net book value of the assets is as below:
- Original Purchase cost here means the purchase price of the asset paid at the time when the company purchased the assets.
- Accumulated depreciation here means total depreciation charged or accumulated by the company on its assets till the date of the calculation of the net book value of the asset.
Net Book Value Calculation Example
Let’s assume that the company Jack ltd purchased plant and machinery on January 1, 2011, worth $800,000 having a useful life of 10 years. The company has the policy to depreciate all assets annually using the straight-line method of depreciation. Calculate the net book value of the asset for the financial year ending on December 1, 2018.
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Answer
For the case of the company as given above, the purchase price of the asset is $800,000 on January 1, 2011. The useful life of the asset is 10 years, and the company has the policy to depreciate all assets annually using the straight-line method of depreciation. So, we calculate the depreciation, which will be charged every year, by dividing the purchase price of the asset with the useful life of the asset.
In order to calculate the net book value, accumulated depreciation charged till the financial year ending on December 1, 2018, will be calculated for the 8 years.
So, the NBV of the asset at the end of the financial year 2018 that will be reported on the balance sheet of the company comes to $16,000.
Advantages
- The NBV of the company is the most used financial measure while valuing the companies and is measured for all the assets, whether they are tangible assets like building, plant & machinery, or intangible assets like a trademark, copyright, etc.
- At the time of liquidation of the company, the valuation of the company is based on its NBV of the assets, and it is the main base for measuring assets value.
- The net book value is used for calculating various financial ratios. These ratios, calculated using net book value of an asset, helps in knowing the company’s market returns and stock market price.
Disadvantages
- The main disadvantage of the company’s net book value is that it is not same as the market value of the company as it is the cost of an asset less accumulated depreciation and is generally far away from the market value or maybe it can be close to the asset’s market value but generally never equals to the market value.
- It is considered while evaluating the growth of the company. Still, it is not a correct indicator measuring the growth prospects of the company as the book value can be lower than the earning potentials of the company.
- There is a possibility that the NBV of the asset is not calculated correctly as calculation of book value is very critical as it requires various compliances with applicable laws and standards. So deriving actual book values is sometimes difficult, and using it as a base for evaluation may lead to wrong decisions.
- This changes over a period of time. Therefore relying completely on the NBV can make the asset valuation inappropriate.
Important Points
- The NBV of the asset keeps on changing and generally, in case of the fixed asset it keeps on declining due to the effects of depreciation or depletion and at the end of the useful life of the fixed asset, the NBV of the fixed asset is equal to its salvage value approximately.
- Generally, the companies value their assets at cost or market price, whichever is lower. In case the market price of the asset is less than its cost, then the NBV of the asset has to be its market price. In such a case, the impairment of the asset is done, i.e., lowering the asset net book value to its market price, which leads to sudden downfall in the value of the asset.
- The market price of the asset is different from its NBV at any point in time. It is as per the company’s policy that how quickly or slowly the asset is depreciated. If the company depreciates its asset using accelerated depreciation, i.e., allowing a higher deduction in the beginning years of the asset, then in the initial years, the net book value of the asset will be less than its market value.
Conclusion
Net book value is the cost of the asset at which the asset is purchased, which includes the purchase price of the asset plus all expenses that are incurred in making the asset ready to use less the accumulated depreciation or any impairment losses. It is considered to be the most used financial measure for the valuation of the company, and the net book value is most cases is different from the market value of the asset.
It is the base of reporting of the figures in the balance sheet of the company. Primarily for the analysis of the growth potentials, the investor refers to these net book value figures only. Hence, the companies should focus on the correct calculation of such figures before reporting them in the financial statements.
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