Monday, November 2, 2009

What is Face value and book value?

Past few posts we have been metioning this word (face value) a lot. So, what is face value? How is it different from the market value of the share? Why do we need this? How does it matter to me as a share holder? We will try to answer some of these in this post.

Face Value

By the definition of it, Face value is the value of a coin, stamp or paper money, as printed on the coin, stamp or bill itself by the minting authority. While the face value usually refers to the true value of the coin, stamp or bill in question (as with circulation coins) it can sometimes be largely symbolic, as is often the case with bullion coins. For example, a one troy ounce (31 g) American Gold Eagle bullion coin was worth and used to sell for about $670 USD at current market prices (as of July 17, 2006) and yet had a face value of only $50 USD.

For a share this is decided by the company issuing it, at the time of initial offering .It is mentioned on the face of share, Bond certificate or other financial instrument. Face value has nothing to do with market value of the share. Market value of shares changes depending on several conditions. Face value changes only when splitting takes place.

Let me use an example. Suppose,  you want to start a Company with the Capital of Rs. 1,00,000. Now, to arrange this money you take help from  friends and relatives. In exchange, you issue shares of your company, it can be 100 shares, each of the Face Value of Rs. 1,000; or 1,000 shares of Rs. 100 each any such value.

Now let us bring in other value, the Book Value.

Book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities

Suppose your company grows 10 times in a given period of time, and it is worth Rs. 10,00,000. The price of the share of your Company will also grow 10 times, i.e. the book value of a share of the face value of Rs. 10 will become Rs. 100. In case of a loss on the other hand, if your company is  worth only Rs. 10,000, the book value of the share of face value Rs. 10 will become Re.1 only. The Shares are first valued on their Book Value and then by the future prospects or risks involved. If the future prospects are good, I will buy a share (issued by you for Rs. 10 FV, now at Rs. 100 BV) for Rs. 120 or Rs 280 (market value). This will depend on the Market, at what price the holder of the share in your company, is willing to sell. And, suppose, your Company is making losses, I will not buy the share of FV Rs. 10, now available at Re. 1, even if the holder agrees to sell at Re. 0.40. And that is the reason why the shares of different companies sell at different prices.


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