Most small business owners first see a value for their company on the balance sheet. That figure is known as the book value of the business. Business book value is what remains after subtracting total liabilities from total assets. This number rarely matches the fair market value of a business, and the difference can be large. Below, we explain how business book value is calculated, why it often differs from fair market value, and when each figure is useful.
As a professional appraisal firm, Peak Business Valuation often provides conclusions of fair market value for small business owners. We can support transactions, financing, succession planning, and tax reporting with a credible valuation report. If you have any questions about how we can assist, schedule a free consultation below to get started.
What is Business Book Value?
Business book value is the net worth of a company as recorded on its balance sheet. An owner calculates it by subtracting total liabilities from total assets. Many financial statements list book value as owner’s equity or shareholders’ equity.
Accounting rules determine how businesses calculate book value. Under those rules, companies record assets at historical cost. This is the amount they first paid for the assets. Companies then reduce the value of most assets over time through depreciation. As such, business book value reflects the accounting history of a company.
What is Fair Market Value?
Fair market value is the price a business would sell for between a willing buyer and a willing seller. Both parties know the company well, and neither is under pressure to close the deal. This is the most common standard of value when valuing small businesses. It is formally defined by IRS Revenue Ruling 59-60.
Unlike book value, fair market value looks forward. When calculating fair market value, a business appraiser looks at the earnings and cash flow a buyer can expect the business to generate in the future. They also consider growth potential, risk factors, and recent sales of similar businesses.
Key Differences Between Business Book Value and Fair Market Value
The two standards of value answer different questions. One records what a company owns and owes according to its accounting records. The other estimates what the company is worth in the market today. Below, we outline the main differences between business book value and fair market value.
- Basis of Measurement: Business book value depends on historical cost and accounting policy. Fair market value depends on current market conditions and the earnings a company produces.
- Treatment of Intangibles: The balance sheet records intangible assets only when a company buys them. Fair market value also accounts for brand strength, customer relationships, and other intangible assets the business has built.
- Time Orientation: Book value reports what a company has already recorded. Fair market value considers future cash flow projections and the associated risk.
- What the Figure Covers: Business book value measures the owner’s equity after debt. Fair market value can measure either equity or the operating business before interest-bearing debt.
- Purpose: Business book value supports financial reporting, lending covenants, and tax records. Fair market value supports sales, financing, succession planning, and estate matters.
In each case, the figure an owner needs depends on the decision they need to make.
If you are seeking a credible conclusion of fair market value, it is best to work with a certified business appraiser. Peak Business Valuation regularly values small businesses throughout the United States. Schedule a free consultation below to learn more.
Why Book Value May Differ from Fair Market Value
As mentioned before, a business’s book value and fair market value rarely match. Below, we highlight four of the most common reasons for the difference.
Assets and Liabilities May Not Reflect Market Value
The balance sheet records equipment, vehicles, and real estate at historical cost minus accumulated depreciation. For instance, a fully depreciated machine may carry no book value even though it still runs. As such, an appraiser restates each asset and liability at its current value before estimating fair market value.
Key Intangible Assets May Not Be Recorded
Accounting standards allow a company to record goodwill only when it buys another business. But a brand, loyal customer base, trained workforce, and referral network are built over time. Since the company did not buy them, they do not appear on the balance sheet. However, these intangible assets often make up a large part of what a buyer is willing to pay for a small business. To learn more, see The Impact of Goodwill on a Business Valuation.
Fair Market Value Reflects Earning Capacity
For most buyers, a business’s earning capacity is its most important asset. Two companies can report the same book value while one of them generates twice the cash flow. Under the income approach, an appraiser projects future cash flow and applies a discount rate that reflects risk. As a result, the conclusion of fair market value can sit well above or well below the figure on the balance sheet.
Unique Business Risks and Strengths Affect Value
Fair market value also accounts for the business risks and strengths a company has. Factors like customer concentration, owner dependence, and industry conditions influence what a buyer will pay. Business book value does not account for these key drivers.
Why the Difference Matters
Business book value has several practical uses. Lenders review it when assessing a borrower’s financial position, and accountants rely on it for financial reporting and tax records. Fair market value answers a different question. It estimates what a company is worth today in an open-market sale.
That distinction matters in several common situations. First, an owner setting an asking price needs fair market value, since book value often understates what the market will pay. Next, a lender financing an acquisition needs an independent conclusion of fair market value to support the loan. Moreover, estate and gift tax filings depend on fair market value as of a specific date.
Peak Business Valuation can provide a credible conclusion of value for your business. Schedule a free consultation today if you have any questions.
Conclusion
Business book value and fair market value measure different things. Book value records what a company owns and owes under accounting rules. On the other hand, fair market value estimates what the business would sell for today. It accounts for intangible assets, earning capacity, and risk. Owners who understand both figures are better prepared for a sale, a loan application, or a tax filing.
Peak Business Valuation is a professional appraisal firm that provides independent conclusions of fair market value for small business owners across the country. We are happy to answer any questions you may have about the value of your company. Schedule your free consultation with Peak Business Valuation below to get started.
