What is modified book value?
Modified book value is a valuation metric used to determine the value of a company based on the current market value of its assets and liabilities. In other words, modified book value adjusts the value of a company’s assets and liabilities to reflect fair market value. Because assets are recorded at their original or historical cost, the updated market value of these assets may vary significantly from their historical cost. For example, marketable securities held by a company may have a market value that differs significantly from their historical value.
The central theses
- Modified Book Value is a metric used to determine the value of a company based on the current market value of its assets and liabilities.
- Because assets are recorded at cost, the updated market value of the assets could be very different.
- As a result, modified book value can provide a more up-to-date valuation of a company.
Understand modified book value
The modified book value asset approach assumes that the value of a company can be determined by estimating the value of its underlying assets. Before determining a company’s modified book value, it is important to first understand the book value of the company. A company’s book value is typically considered to be the value of its assets less all debts and liabilities. In other words, if a company were to sell all of its assets and pay off all of its liabilities, the remaining amount would be its book value. Investors use book value as a measure of whether a company is over- or undervalued.
Traditionally, when determining book value, the value of assets on a company’s balance sheet is included in the calculation. However, from an accounting perspective, the values of these assets are recorded based on their original purchase price, known as historical cost. In reality, these assets can fluctuate over time and differ significantly from their historical cost.
For example, land would be an asset that would likely appreciate in value over time. Conversely, manufacturing assets would likely decline in value as technological advances could eventually render them less valuable or obsolete. Modified book value goes one step further by calculating the current value of the company’s assets and liabilities to provide a more up-to-date valuation.
Components of modified book value
The types of assets included in the calculation of book value and modified book value include fixed assets that are physical or tangible in nature and intangible assets that are not physical. Below are some examples of a company’s assets and liabilities.
Below are examples of tangible or fixed assets:
- factories and buildings
Below are examples of intangible assets:
Liabilities are what a company owes, which can include both short-term and long-term financial obligations. Some examples of liabilities are:
- Trade payables, which represent monies owed to suppliers and vendors
- Dividends payable, which are short-term cash payments to investors
- Long-term debt, e.g. B. Money borrowed from a bank
- pension benefits
If modified book value is used
Typically, modified book value is used in cases where a company faces bankruptcy or is in financial distress. Creditors, such as banks, may have outstanding loans to the company. As a result, the bank may request updated values of the company’s assets.
From there, creditors can determine the liquidation value of the assets, which is the amount of money they would receive if they sold all of the assets. If the total asset value on a company’s balance sheet is less than its total liabilities, creditors would likely suffer a loss on their outstanding loans to the company.
How modified book value is determined
Modified book value attempts to create a more realistic valuation of a company (compared to book value) by determining the current (or fair) market value of assets and liabilities. Once the updated valuations are determined, the modified book value is calculated by subtracting the total fair value of the entity’s assets less the total fair value of its liabilities.
As part of the modified book value approach, the assets may have to be adjusted to realistic expectations. Short-term assets such as cash would already be recognized on the balance sheet at market value. However, a company’s receivables owed to a company on credit by its customers for products already sold may need to be discounted. For example, outstanding receivables older than 90 days could be discounted by a certain percentage since it would be unlikely that the company would receive the full amount owed.
Although some assets would likely have appreciated in value since their purchase, such as B. real estate, would be other assets, such. B. Vehicles, are likely to be worth far less than their historical acquisition cost. Technology such as computers and software would likely have lost value as well. Once all of the market values of all assets and liabilities are determined, the modified book value can be calculated by subtracting the two totals.
Pros and cons of modified book value
The advantage of the modified book value approach in the valuation lies in the in-depth examination of the company. Individual asset valuations can provide a clear understanding of where the company is generating the most value. If valuations are higher as a result of the adjusted assets, this can improve the negotiation process when a company restructures its debt for a creditor.
The main disadvantage of modified book value is the high cost involved in implementing its calculation. Several specialized appraisers may need to be engaged and the process is far more time consuming than the other appraisal methods such as B. the book value. Also, the average investor would not have access to the specific assets or their values of a publicly traded company. As a result, it would be difficult to provide a fair market valuation of a company’s assets and liabilities using only the total amounts reported on the company’s balance sheet.
Other ways to rate companies
Businesses can be valued in several other ways, including some of the following methods:
Market capitalization is calculated by multiplying the company’s share price by the total number of shares outstanding.
Times Revenue Method
The times revenue method applies a revenue stream generated over a period of time to a multiple that depends on the company’s industry and economic environment.
Discounted cash flow
The discounted cash flow method (DCF) measures a company’s expected cash flows (e.g. sales) and takes into account the cost of capital, e.g. B. the cost of borrowing.
Businesses may also employ firms that specialize in business valuations to determine a company’s value for a variety of purposes including mergers or acquisitions, shareholder transactions, estate planning, and financial reporting.