Adjusted Book Value Details

Adjusted book value is one of many valuation methods analysts and investors use to determine the worth of an organization. A valuation method refers to the general process of calculating the financial value of a whole company or a unit of a business. To determine which valuation method to use, it is important to recognize the industry in which the company involves itself as well as its financial situation, among other things. One valuation method may be appropriate for one type of company but not another.

In the case of adjusted book value, it is most suitably used for assigning value to firms that are on the brink of insolvency or bankruptcy. By using adjusted book value, analysts can estimate the price at which these companies could liquidate their assets to determine the bottom line of the whole company’s market price. The market value of a company will likely be different from its historical value so that adjustment by the means of appraisal is necessary to obtain its fair market value. Analysts and investors may also use adjusted book value to analyze companies holding a large amount of physical assets in comparison to total assets.

Some types of assets or liabilities, like cash and current debts, don’t need adjustments and can be recorded as is. However, other items like accounts receivables, inventory, and lands will need adjustment so that they can reflect their real values. For instance, receivables that are already long past their due date will get downward adjustment since it is less likely that the company will receive actual payment. On the other hand, short receivables that are due under 30 days will get a more generous appraisal.

Example of Adjusted Book Value

ABC Corporation is a company that is in a state of insolvency heading to bankruptcy. In a few weeks, analysts predict the company will begin the legal process of liquidating assets and property to pay off its debts. Since a large portion of the total assets the ABC Corporation owns are in the form of long-term assets, analysts need to make huge adjustments to the valuations of the company as a whole. More specifically, properties such as buildings, lands, and other fixed assets will get a considerable value adjustment to reflect their fair market values.

Property, plant, and equipment (PP&E) will usually get a lower value compared to their historical cost. This is the case as these assets are subject to depreciation and would inevitably suffer a decrease of value over time. This is different for lands that typically have increasing value as they have perpetually limited amounts, i.e., they are appreciating instead of depreciating. In this case, lands will generally get higher prices compared to their historical costs.

Significance of Adjusted Book Value

In some cases, adjusted book value can provide a way for analysts to accurately picture the true value of a whole company or a part of it, at least physically. Recall that book value equals total assets minus intangible assets minus liabilities. This fact introduces a potential drawback to the valuation method.

The main weakness of adjusted book value is that it doesn’t take into account intangible assets that may include copyrights, brand recognitions, and patents. This is the case as adjustments are only made to assets or properties listed on financial reports. This valuation method also doesn’t take into consideration liability that may happen if an uncertain future event makes it appear.

Analysts and investors should also not treat adjusted book value as a factual representation of how profitable a company is in its day-to-day operation.