What Is Modified Book Value?
Modified book value is a valuation metric for determining a company's worth based on the current market value for 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. Since assets are recorded at their original or historical cost, the updated fair market value of those assets could be quite different from their historical costs. For example, marketable securities held by a company may have a market value that is quite different from their historical value.
- Modified book value is a metric for determining a company's worth based on the current market value of its assets and liabilities.
- Since assets are recorded at their historical cost, the updated fair market value of the assets could be quite different.
- As a result, modified book value can provide a more up-to-date valuation of a company.
Understanding Modified Book Value
The asset valuation approach of modified book value 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's important to first understand the company's book value. The book value of a company is typically considered the value of its assets minus all of its debts and liabilities. In other words, if a company were to sell everything it owns and pay off all of its liabilities, the remaining amount would be its book value. Investors use book value as a metric to determine if a company is overvalued or undervalued.
Traditionally, when determining book value, the value of the assets on a company's balance sheet is considered in the calculation. However, from an accounting standpoint, the values of those assets are recorded based on their original purchase price, called historical cost. In reality, those asset values can fluctuate over time and be quite different than their historical cost.
For example, land would be an asset that would likely increase in value over time. Conversely, manufacturing equipment would likely decrease in value since technological advances might eventually make it less valuable or obsolete. Modified book value takes things a step farther 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 book value and modified book value calculations include fixed assets, which are physical in nature or tangible, as well as intangible assets, which 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:
- Patents, which represent legal protection and ownership for an invention
- Intellectual Property, such as a company's trademark
Liabilities are what a company owes, which can include both short-term and long-term financial obligations. Some examples of liabilities include:
- Accounts payables, which represent money owed to suppliers and vendors
- Dividends payable, which are cash payments to investors due in the short term
- Long-term debt, such as money borrowed from a bank
- Pension benefits
When Modified Book Value Is Used
Typically, modified book value is used in cases when a company is facing bankruptcy or is in financial hardship. Creditors, such as banks, might have outstanding loans out to the company. As a result, the bank may require 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, the creditors would likely take 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 (versus book value) by obtaining the current (or fair) market value of the assets and liabilities. Once the updated valuations are determined, modified book value is calculated by subtracting the total fair market value of the company's assets minus the total fair market value of its liabilities.
As part of the modified book value approach, the asset values may need to be adjusted to realistic expectations. Short-term assets, such as cash, would already be recorded at fair market value on the balance sheet. However, a company's accounts receivables, which represents money owed to a company on credit from its customers for products already sold, may need to be discounted. For example, outstanding accounts receivables that are more than 90 days old might be discounted by a certain percentage, since it would be unlikely the company could get paid the full amount owed.
Although some assets would have likely increased in value since they were purchased, such as real estate, other assets, such as vehicles, would likely be worth far less than their historical cost. Technology, such as computers and software, would also likely have depreciated in value. Once all of the fair market values of all of the assets and liabilities are determined, modified book value can be calculated by subtracting the two totals.
Advantages and Disadvantages of Modified Book Value
The advantage of the modified book value approach to valuation is that it involves an in-depth examination of the business. The individual asset valuations can provide a clear understanding of where the business generates the greatest value. If the valuations are higher due to the restated assets values, it can improve the negotiating process when a company is restructuring its debt for a creditor.
The major disadvantage to modified book value is the high cost associated with implementing its calculation. Several specialized appraisers may need to be hired, and the process is far more time consuming than the other valuation methods, such as book value. Also, the average investor wouldn't have access to the specific assets, nor their values, of a publicly-traded company. As a result, it would be difficult to create a fair market valuation of a company's assets and liabilities using only the total amounts recorded on the company's balance sheet.
Other Ways to Value Companies
Businesses can be valued in several other ways, including some of the methods below:
Market capitalization is calculated by multiplying the company’s equity share price by its total number of shares outstanding.
Times Revenue Method
The times revenue method takes a stream of revenues generated over a certain period of time and applies it to a multiplier, which depends on the company's industry and economic environment.
Discounted Cash Flow
The discounted cash flow (DCF) method measures the expected cash flows from a company (such as revenue) and factors in the cost of capital, such as the cost of borrowing money.
Also, companies can hire firms that specialize in business valuations to determine a business's value for a number of purposes, including a merger or acquisition, shareholder transactions, estate planning, and financial reporting.