Fair value

Definition

Fair value is the price receivable to sell an asset (or payable to transfer a liability) in an orderly transaction between market participants at the measurement date. Some assets are held at fair value rather than historical cost.

In plain terms

It is the honest market price today, not what you paid years ago. Property held at fair value can carry far above its original cost.

Why it matters for your company

Fair value drives security valuations and some balance-sheet figures. Lenders test book values against fair value when sizing a facility. See valuation.

In practice

Picture a UK limited company that bought a warehouse some years ago and has held equipment and a small investment portfolio since. Under historical cost, all three would sit on the balance sheet at what was originally paid, less any depreciation. Fair value asks a different question at each reporting date: what would each of these actually fetch if sold today, in an orderly sale, to a willing and informed buyer.

For the warehouse, that might mean the current commercial property market has moved well away from the purchase price. For the equipment, it could mean specialist machinery has aged in a way accounting depreciation schedules never anticipated. For the investment portfolio, fair value is usually just today's quoted price. The point is not that one figure is 'right' and the other 'wrong' — book cost and fair value answer different questions, and directors need to know which one a particular number in their accounts is actually telling them.

How lenders read it

When a lender is asked to size a facility against a company's assets, historical cost figures on their own are usually not enough — they tell you what was paid, not what stands behind the lending today. A lender will typically want to understand current fair value, often supported by an independent valuation, particularly for property, plant or anything whose market price could have drifted a long way from the number in the accounts.

A gap between carrying value and fair value is not automatically a problem, but it is something a lender will want explained. A director who can speak confidently to why an asset's fair value differs from its carrying value — and can point to independent evidence for the fair value claimed — is in a materially stronger position than one who cannot.