You might have heard terms such as “fair value,” “market value,” and “book value” thrown around frequently in the world of business and finance, and there is a good chance you might have considered all of these to refer to a fairly similar number. For business owners, having multiple definitions of these terms can create confusion and lead to significant challenges in decision-making, financial reporting, and strategic planning, and it is important to add that when looking at these in a little more detail, they do have several different meanings and understanding which of these definitions apply to your situation can be very important.

Now it is important to highlight that while these various terms do carry different technical definitions, there are instances where two or more of these terms could have the same or at least a similar value. Also, some of these definitions only come into use in specific situations, depending on the industry and motivations for the valuation. In our previous article, we talked about the difference between price and value, and how this is important to businesses, and about the challenges with these varying definitions of value. In this article, we take a closer look at these varying definitions and hopefully create some order between the chaos of definitions.

So first let’s break down these terms and explore the implications of their varying definitions.

1. Book Value or carrying value: The most easily identifiable of all, this is the value of an asset or business as recorded on the balance sheet, calculated as the original cost of the asset minus any accumulated depreciation, amortization, or impairment costs. It represents the net asset value of a company from an accounting perspective. This is usually a good starting point for understanding the baseline value of a business.
2. Adjusted Net Book Value (ANBV): A derivation of the book value, and commonly used by valuators to determine the actual floor value of a business, the ANBV of a business is based on adjusting the value of the various assets and liabilities of a business to their fair value in order to arrive at a value for the overall business. This is also a commonly used approach in asset-heavy businesses such as manufacturing and logistics.
3. Fair Value (FV): Probably the most popular term to business owners, and one that is commonly present in various accounting standards including the IFRS and US GAAP, this term typically refers to the estimated worth of an asset or liability based on current market conditions. It is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
4. Fair Market Value (FMV): A term more commonly used in Canada, and well defined by the CBV Institute and CRA, the FMV is similar to FV but emphasizes the willingness of both a buyer and a seller to engage in a transaction, given that both parties have reasonable knowledge of the relevant facts. This term is often used in legal contexts and tax assessments, and it is probably one of the most important terms for business owners based in Canada.
5. Market Value: Market value represents the amount at which an asset would trade in a competitive auction setting. It reflects what the market is willing to pay for an asset at any given time, which can fluctuate based on various external factors.
6. Replacement value: Often used in the world of intellectual property and certain types of assets, this is the cost of replacing a business or asset with a similar one, which could be in the form of cost of re-creating an asset from scratch or replacing it with a similar one.
7. Intrinsic value: refers to the true, inherent worth of an asset, investment, or company, based on its fundamental characteristics rather than its current market price, which includes a business’ cash flow and earnings potential. Used commonly by investors as they try to identify undervalued businesses for investment opportunities. This is also a particularly important metric for startup investors, where investment risk is significantly higher.

The Issues Business Owners Face

Having a variety of definitions can absolutely create confusion over which term to use and when any of these might be applicable to your situation, given the myriad of other factors that already need to be considered. Some key challenges that do steam from this issue are:

• Inconsistent Valuations: Different stakeholders—investors, lenders, auditors, and tax authorities—may interpret fair value differently. For example, a business owner seeking a loan might want to use a higher fair market value to present a more favorable financial position, while a tax authority or an investor might apply a stricter or different definition. This can lead to discrepancies that complicate negotiations and reporting, and comparisons of performance between different companies. Choosing the right definition and following this consistently is therefore very important.
• Regulatory Compliance: Different accounting standards, such as the US GAAP and IFRS, and here in Canada, the CBV Institute, define fair value differently. For business owners and investors operating in multiple jurisdictions, aligning these definitions can be daunting and may require additional resources or expertise.
• Subjectivity in Estimation: Fair value often requires subjective judgment, especially when market data is limited or unavailable, and definitions often help to direct this subjectivity in certain ways. Business owners may face difficulties in determining fair value accurately, leading to potential misstatements in financial reporting. This subjectivity can also raise concerns about the reliability and transparency of financial information.
• Market Conditions and Timing: Market fluctuations can cause rapid changes in value, which can be problematic for business owners who need to make timely decisions based on current valuations. An asset valued one day, using a certain definition, may not hold the same value the next due to changes in market conditions, economic downturns, or shifts in consumer demand.
• Investment Horizon: The appropriate definition of value may vary based on an investor’s time horizon. Short-term traders may focus on market value, while long-term investors might prioritize intrinsic value, leading to differing strategies.

So what is the best way to navigate this fair value dilemma?

Given the variety of factors that need to be considered when carrying out a fair value exercise, to mitigate the challenges it is important to consider the following:

• Clearly Define Fair Value: Establishing a clear and consistent definition of fair value that is appropriate for their specific business context can go a long way in ensuring consistency and clarity.
• Use Appropriate Valuation Techniques: Select valuation techniques that are reliable and appropriate for the type of assets being valued and within the context of the definition being applied.
• Consider External Validation: Engage independent experts to carry out or validate valuations, particularly for complex assets or in situations where regulatory compliance is key.
• Disclose Valuation Methods: Provide transparent disclosures about the valuation methods used and the key assumptions underlying the valuations. Keeping a record of these assumptions helps improve consistency and comparability of performance.
• Monitor Market Developments: Keep abreast of market developments that could impact the fair value of assets, and regularly consult with experts to determine their impact on valuations.

Conclusion

Understanding the nuances of fair value and its related terms is crucial interpreting performance, unravelling the impact of market changes and making informed financial decisions. The inconsistency in definitions can often create confusion and hinder effective communication with various stakeholders.

To navigate these complexities, it’s essential to understand these terms in more detail along with their implications, and when needed, work closely with financial advisors and accountants who can help clarify these terms and their implications. By gaining a clearer understanding of fair value, business owners and investors can better position their businesses for growth and stability in today’s dynamic market landscape.