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Introduction
Organizations usually aim at making profit and minimizing the total costs. However, for effective performance to be achieved, the firm must perform well. This also depends on the value of the company. Companies value their assets using either the market value or the book value that is obtained from the balance sheet. Both of these methods provide the valuation of the company. However, there are some differences as examined in this paper. The paper also will examine the book value and the market value of two organizations operating in UK.
Market value
According to Beattie, Goodacre & Thomson (2006), the market value of an organization is the price of the organization as it trades on the market (p. 89). Knowing the market value of an organization is very important to the firm because it helps in determining the market price of trading the company in public. The price is usually arrived after the bargaining between the willing buyers and the willing seller of the company shares. Neither of the parties is required to act and both buyers and seller of the company shares have enough knowledge of the relevant facts regarding the organization. Managements that do not know the market value of their organizations will often price the firm too high for buyers or too low hence leading to negative financial results.
According to Dhanani (2005), professional appraiser should be used by an organization to determine the market value of the firm by making comparisons with other similar companies trading in public (p. 1642). Using comparables, the appraiser can also determine the reasonable market price of the firm assets (shares) that can be asked of the buyers. The market value of the assets of an organization can change. According to Lasher (2000), the market value can be affected by factors such as improvements of the organization and the company condition that affect positively the reputation of the company (p.163). A positive company reputation affects positively the goodwill of the firm hence increase in the market value of the company. The improvement in the innovativeness and quality of the products of the company can increase the demand from customers and the profit realized by the company. Larry (1981) posits that the overall value of the products of the firm affects the overall market value of the company (p.125).
Balance sheet value
According to Brealey and Meyers (2006), a balance sheet is a financial management tool that indicates the financial position of the organization at a given period (p.106). A good accounting system provides a balance sheet as a financial report for the organization. The management depends on the balance sheet to provide the book value of the organization. The balance sheet contains relevant information such as debt position of the organization, what is owed share of the owners in the organization. The net worth if the organization can be determined by the comparisons of the past balance sheets and the current balance sheet. The information that can be determined is the growth trends in assets and loans of the organization (Langemeier & Klinefelter 2010, p. 2).
The balance sheet indicates the amount of capital that the owner has in the organization. The owner’s equity can be determined by deducting all liabilities from total assets. The assets of the firm may include cash in hand, bank accounts, inventory, accounts that the firm receives equipment and buildings. Liabilities on the other hand comprise of the unpaid accounts and mortgages. The relationship between the assets and the liabilities of the organization can be expressed as:
Net worth = Assets – Liabilities
The assets are categorized into current and fixed assets while liabilities are grouped into current liabilities and long-term liabilities. They include company assets such as cash in hand and account receivables. Fixed assets comprise of assets that are used to support the operations of the organization such as machines, land, and buildings. The values of fixed assets are more permanent as compared to current assets. Current liabilities are notes or money that is payable within a short period specifically within one year. This may include accounts payable to creditors, accrued interest, and income taxes. Non-current liabilities include liabilities that are payable over long periods such as land contracts and mortgages (Van-Horne & Wachowicz 2001, p. 122).
The balance sheet is used for many purposes. According to Dirk (2009), creditors utilize the balance sheet to evaluate the financial position of the organization (p.403). The financial position is important to creditors because it determines the ability of the firm to repay its debts. The owner also can find the balance sheet very useful in terms of determines the owner’s equity in the firm. He can also determine the trends in the net worth by comparing the present balance sheet with previous balance sheets. Additionally, the owner can use the balance sheet to support the request for funding. The balance sheet provides information on how the firm can meet its liabilities and obligations as they fall due. According to Brigham, Gapenski & Ehrhardt (1999), the comparison of total current assets and fixed assets is essential for provision of information on amount of capital that is tied up in business (p.63).
Valuation of assets
The assets of the organization are usually valued using two methods: the current market value and the cost. The market value is the value of the asset in the market if it was to be sold on the given date of the balance sheet less the purchase costs. The cost of the asset is original cost of the asset less the amount of accumulated depreciation. Therefore, the method of valuation used in the preparation of the balance sheet affects the financial ratios that are generated from the balance sheet statement. The values of the assets and liabilities on the balance sheet provide the value of the firm (Copeland & Weston 1992, p. 216). It is recommended that the balance sheet be prepared using both the market value and the cost. The balance sheet can be evaluated using financial ratios, comparison with balance sheets from previous years and balance sheets from other firms in the industry.
Case Studies
TESCO plc
Tesco plc is a multinational retail corporation that sell products in stores and online. The organization operates in superstores, homeplus, and hypermarkets. The company deals mainly in food products and non-food products such as clothing and beauty products. The company also provides several services including financial services, telecom services and website selling services.
Market value
The market value of the stock of Tesco Plc has fluctuated over a five-year period. Since 2006, the company’s market value rose as high as $491 in 2008. However, the market value of the company began declining hitting a low of $274.7 in 2008. However, the market value of the company began to improve once again. The value of the company rose top a high of $450 in the year 2010. The fluctuation of the company’s market value can be attributed to the high level of uncertainty that accompanied the 2008 global financial crisis. Due to the crisis, many investors were uncertain about the future of business and therefore, could not invest in the organization (Modigliani &Miller 1958, p. 275). This led to the decline in the market value of the company. However, after the global recession, the business environment began to improve and the market value of the company began to rise too.
BT Group Plc
BT Group Plc is a multinational organization that provides communication services and solutions. The company is involved in activities such as networking IT services, local, national, and international telecommunication services. The company is listed in the UK stock exchange in London (BT 1).
Market Value
The market value of BT Group Plc fluctuated over the five years as indicate din the chart below. In the financial year 2006, the market value was $190. The market value of the company improved to $330 in the year 2007. However, as the global financial crisis approached, the market value of BT Group plc began to drop to as low as $74 in the year 2009. After the crisis, the market value began to increase again to a high of $181 in 2010. The fluctuation in the market value affects the investors’ choice to invest in the organization. This is because the investors are usually not sure of the future performance of the firm. The decreasing volume of shares traded in the course of the five years indicates this. When compared to Tesco Plc, BT Group has a lower market value compared to Tesco plc. Therefore, investors should find Tesco plc appealing to invest in it.
Profitability ratios
Profitability ratios provide the relevant information concerning the profitability of the firm. The ratios guide the firm and external users on the financial performance of the firm the ratios include the gross profit margin, net profit, sales turnover and return on invested capital. The gross profit margin indicates the level of growth in the gross profit of an organization in comparison with the previous financial period and the industry. The net profit is the profit of an organization after all tax and other costs are deducted. Just like the gross profit margin, the net profit indicates the performance f the organization in a given financial period (Morning Star 2011,p. 2).
Given the financial records of Tesco and BT Group Plc, the profitability ratios of the company can be explained. The gross profit margin for Tesco plc in the financial year 2010 was 5.5%. The gross profit margin for the company remained constant for the five-year period. In 2006, the gross profit margin for Tesco plc was 5.6%. The gross profit margin rose to a high of 6.2 in 2007 and began declining again. The decline in the gross profit can be attributed to the global financial crisis that affected many firms as well as consumers in UK. The net profit margin is another ratio that determines the profitability of the organization. The net profit margin for Tesco Plc rose from 5.5% in the financial year 2006 to 5.6% in 2008. However, it dropped to 5.3 in the financial year 2010. The decline and the stagnation in the growth of the net profit margin for Tesco Plc can be attributed to the economic slow down and eventually the global financial recession (Equinity 2010, p.1).
Another profitability ratio is the return on assets. The return on assets for Tesco plc in 2006 was 7.3%. The ratio increased to 7.9% in 2007 and began to decline there after to 5.0% in 2010. The decline in return on the assets can also be attributed to the global financial crisis. The return on investment ratio indicates the income that the firm receives on the invested capital. The investment capital for Tesco Plc was 11.98% in 2006. The ratio increased to 12.73% in 2007. However, it decreased gradually to 8.8% in 2010. The declined can be attributed to low investment activities and high uncertainties following the global financial crisis (Morning Star 2011, p.2).
The gross profit margin for BT Group rose from 14.73% in 2006 to 15.04% in 2007. However, the gross profit margin thereafter to 5.4% in 2009, only to begin increasing again to 10.21% in 2010. The fluctuations in the gross profit margin of the company can be attributed to the uncertainties surrounding the business environment following the global financial crisis in a similar five-period. The net profit margin for BT Group Plc also fluctuated just like the gross profit margin. The net profit rose from 11.15% in 2006 to 11.92% in 2008. However, the net profit realized began decreasing and it fell to a low to as low as 1.4% in 2009. The net profit margin began to increase in the financial year 2010 to 6.3%. The fluctuations in the profitability of the company can still be attributed to level of low investment activities and the uncertainties accompanying the global financial crisis (Morning Star 2011, p.2).
Return on earnings from investments decreased over the five-year period. The ratio decreased from 27.97% in 2006 to 5.83% in 2009. However, the ratio began to increase again in 2010 where it rose to 15.18%. The decline in the returns on earnings from assets can be attributed to the global financial crisis that increased the level of uncertainty in the business environment. The low level of certainty reduced investment activities affecting the returns of the company.
Investor ratios
Investors in the organization usually aim at investing in organizations that can yield high returns (Abuzayed & Molyneux 2010, p.159). Many companies provide options for the investors. The investors can invest in the organization through shares or debentures. However, before investment, investors examine the profitability of the firm so that they can be sure of returns on the invested capital. Investor ratios are simple to understand and provide information on the returns to the investment that the firm offers. Some of the investor information include earnings per share, dividends per share, dividend yield and dividend cover ratio (Morning Star 2011, p. 2).
Investor ratios for Tesco Plc are similar to the ratios mentioned above. The earning per share was $20.1 in 2006. In the whole period of five years, the earnings per share were increasing to a high of $29.3 in 2010. The increase in the earning per share indicates the importance of investing in the organization by investors. It indicates the good financial performance of the company that is favorable for investors (Morning Star 2011, p. 2). The earnings per share for BT Group plc fluctuated for the five-year period. The earnings per share increased from $8.7 in 2006 to 13.83 in 2007. However, the earnings per share decreased to $ -79.88 in the financial year 2009. The EPS began to increase again in the 2010 financial year.
Recommendations
The market vale and the book value of an organization are two methods of determining the value of an organization. The book value uses the financial data of the company contained in the balance sheet whole the market value utilizes the value of the company stock as in equilibrium in the market. The book value method of determining the company value is commonly used because it enables the comparison of the company values over different periods and with different companies in the industry. However, market value can also be used. The market value is good because it is determined in the market by investors (Bowman 1981, p. 262).
The market value is more recommended for use in company evaluation because the method is easy and does not require a tedious process. The book value on the other hand requires the company to use the market value and the cost value of the assets of the organization in order to determine its cost. Where errors are encountered in cost determination due to inflation or depreciation the book value may not give the correct figure leaving the market value to prevail as a sure way of determining company value.
List of References
Abuzayed, B. & Molyneux, P 2010, Market value, book value, and earnings: is bank efficiency a missing link? Web.
Beattie, V, Goodacre, A & Thomson, S 2006, International lease accounting reform and economic consequences: The views of UK users and preparers, International Journal of Accounting, vol.41, no.1, pp. 75-103.
Bowman, R 1981, The importance of a market value measurement of debt in assessing leverage, Journal of Accounting Research, Vol.18, no.1, pp.1-20.
Brealey, R & Meyers, S 2000, Principles of corporate finance, 6th Edition, McGraw Hill Publishers, Boston.
Brigham, E, Gapenski, L & Ehrhardt, M 1999, Financial management theory and practice, 9th Edition, Dryden Press, Orlando.
BT Group 2010, BT Group Plc: Our profile. Web.
Copeland, T & Weston, J 1992, Financial theory, and corporate policy, 3rd Edition, Addison-Wesley Publishing Company, New York.
Dhanani, A 2005, Corporate dividend policy: The views of British managers, Journal of Business Finance and Accounting, vol.37, no.2, pp. 1625-1672.
Dirk, H 2009, Determinants of corporate borrowing: A behavioral perspective, Journal of Corporate Finance, 2009, Vol. 15, no.4, pp. 389-411.
Equinity 2010. Tesco company profile. Web.
Langemeier, L & Klinefelter, D 2010, Balance sheet: A financial management tool. Web.
Larry, D1981, Common stock repurchases: An analysis of returns to bondholders and stockholders, Journal of Financial Economics, vol. 14, no.7, pp. 113-138.
Lasher, W 2000, Practical financial management, South-Western College Publishing, Cincinnati
Modigliani, F & Miller, M 1958, The Cost of capital, corporation finance, and the theory of investment, American Economic Review, vol. 48,no.2, pp. 261-297.
Morning Star 2011, BT Group Plc. Web.
Morning Star 2010, Tesco Plc. Web.
Van Horne, J & Wachowicz, J 2001, Fundamentals of financial management, 11th Edition, Prentice-Hall Publishers, New York.
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