What it means
In everyday speech value simply means worth, but finance splits it into distinct measures that rarely match. Market value is what a willing buyer would pay today, book value is the figure recorded in the accounts, and intrinsic value (an estimate of what something is really worth based on the cash it should produce) is the number an analyst argues for.
These measures matter because a decision usually depends on which one you pick. A lender cares about what collateral would fetch in a quick sale, an acquirer cares about what the future cash flows are worth, and a tax authority may care about a figure set by rule.
The most common way to estimate intrinsic value is discounting, which means shrinking future money to its worth today. A dollar due next year is worth less than a dollar in hand, so each expected cash flow is reduced by a discount rate that reflects both time and risk before the results are added together.
Value is also used in the sense of value creation. A business creates value when it earns more on the money invested in it than that money costs, and it can destroy value while still growing sales if its returns fall short of its cost of funding.
Value is not the same thing as price or cost. Cost is what was paid in the past, price is what is being asked or paid now, and value is a judgement about worth, so the gaps between the three are where investors hope to find bargains and where overpayment hides.
In practice
Real-world examples.
Example
A delivery firm owns vans that appear in its accounts at $300,000 after years of depreciation. A broker says the same vans would sell for $380,000 on the open market. The owner uses the $300,000 for the accounts and the $380,000 when negotiating a sale.
Example
A software company is being acquired. The buyer ignores the balance sheet figure for equipment and instead discounts five years of forecast subscription cash flows. The price offered reflects the buyer's view of intrinsic value, not what the company's assets cost.
Example
A bank is asked to lend against a warehouse of stock recorded at $1,200,000. The bank values the stock at what it would raise in a forced sale, which is $700,000, and lends 70% of that figure, so the loan is $490,000.
Formula
Calculation
Value of a steady cash flow (no growth) = Annual cash flow / Discount rate
Suppose a small rental business is expected to produce $50,000 of cash a year indefinitely, and the buyer wants a 10% return for the risk involved. Value = $50,000 / 0.10 = $500,000. If the buyer feels the risk is higher and demands 12.5%, the value becomes $50,000 / 0.125 = $400,000, so a change of 2.5 percentage points in the required return moves the value by $100,000. This sensitivity is why two sensible people can value the same business differently.Case study
Seen in the real world.
This illustrative story is about a fictional company, Brightwell Joinery Ltd, which makes made-to-measure kitchens. Its owner, Marta, wanted to sell and assumed the business was worth the $900,000 of equity shown in the accounts. Three interested buyers offered between $600,000 and $1,100,000, and she could not understand the spread.
Her adviser explained that the accounts showed what had been spent, not what the business could earn. The buyer offering $600,000 valued only the machinery and stock, while the buyer offering $1,100,000 valued the steady stream of repeat orders from two property developers. Marta chose the higher offer, but only after agreeing to stay for a year to keep those relationships.
The lesson in this fictional example is that value is always value to someone, for a purpose. Marta had been comparing three different measures as if they were one.
Watch out
Common mistakes.
- Treating book value as the true value of a business. Book value records historical cost less depreciation, so it can be far above or below what a buyer would actually pay.
- Assuming there is one correct value for an asset. Market, book, liquidation and intrinsic values answer different questions, and the right one depends on the decision.
- Confusing value with price. Price is what a transaction happens at, while value is a judgement about worth that may be higher or lower than the price.
Questions
People also ask.
What is the difference between value and fair value?
Fair value is a specific, defined measure, usually the price that would be received in an orderly sale between market participants, while value on its own is the general idea of worth.
Why do two analysts value the same company differently?
They make different assumptions about growth, risk and the discount rate, and small changes in those inputs produce large changes in the result.
Can an asset have a value of zero on the books and still be worth something?
Yes, a fully depreciated machine or an internally built brand can carry no recorded value while still being useful or saleable.
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