The book value method is an accounting process that reviews an investment’s return based on financial statements. Most companies prepare accrual-based statements that detail the net income or profit from a company’s operations. Using the book value method, companies can develop an accounting rate of return. Accountants take an average net income or profit for an investment or business opportunity and determine the associated financial returns. Other terms for this process include the financial statement method or simple rate of return.
Net income or profit is a purely accounting figure. Most businesses use this number to determine how profitable normal business operations are in a certain period. A basic income statement includes a company’s revenues, cost of goods sold, and expenses. Subtracting the latter two items from the first provides the net income or profit for a period. Most companies prepare the income statement on a monthly method, with an aggregate statement listing the net income or profit for the entire year.
Using the book value method simply requires a company to add together the net income or profit for a given time period. For example, accountants can provide owners or executives with a six-month review of a project. The formula adds together the net income or profit for each period and divides it by six, the number of months for the review period. The result is an average return for the project or operations. Creating individual income statements for each project allows for a deeper individual analysis on projects using the book value method.
The accounting rate of return also allows a company to create future estimates for income on various projects. Accountants create a historical rate of return for each project. Under the same conditions, the company would expect to make at least this amount of net income or profit. Estimated financial statements and information using the book value method is quite common in business. Companies often need information about upcoming operations in order to provide stakeholders with supporting information for future financial returns.
When using the book value method, companies often remove interest expense and tax expense from normal operating expenses. These two items do not always represent standard operating expenses that affect the accounting rate of return. The basic formula essentially uses normal operating profits determined using accrual-based accounting activities. This process typically provides the best look at the accounting rate of return for a project. Other alterations to this formula are possible in order for a company to properly assess operations.
