Enterprise value, or EV, is a way to measure the total value of a company when it comes to mergers and acquisitions. To calculate this figure, simply add together the market capitalization of the business (the overall worth of all its traded shares) and any total debt that has been accumulated. Then, highly liquid assets such as savings or cash must be subtracted from this figure.
Want to learn more about enterprise value? Keep reading to discover why it’s important and how to use it for financial analysis.
What Is Enterprise Value?
Enterprise value is a financial metric that captures the total value of a company. It takes into account both equity and debt that the company has taken on, including any cash reserves. Essentially, it represents the amount a buyer will likely pay to acquire the entire company.
While market capitalization only considers the value of a company’s equity, enterprise value gives us a more holistic view of a company’s worth. This metric is commonly used in investment analysis, as it helps investors better understand how a company is valued relative to its earning potential. By analyzing a company’s enterprise value, investors can make more informed decisions regarding the profitability and viability of a particular investment.
Moreover, EV becomes indispensable when comparing companies with different ratios of debt-to-equity or capital structures. With the calculation of EV, you add up the company’s equity and total debt, making it possible to compare companies with varying debt-to-equity ratios on a more level playing field.
What Is The Formula Of Enterprise Value?
To find a company’s enterprise value, calculate by subtracting its cash and liquid assets (excluding other securities or stocks) from the sum of its market capitalization and total debt. Hence, the formula of EV is:
EV = Market Cap + Total Debt – Cash
What Are The Components Of Enterprise Value?
Market cap is an important measure of a company’s size. It is calculated by multiplying the number of shares that have been sold to shareholders with their current share price on the market. Market cap gives investors insight into how large a company is- the higher the market cap, the bigger the business. This metric can help investors judge a company’s potential success and growth opportunities.
This is one of the most important liquid assets for a business. It includes savings, paper currency, and checking accounts. However, marketable securities such as stocks are not counted in cash because their value is part of the company’s equity value or market capitalization. When cash is subtracted from a company’s total debt, the result is its net debt. If someone buys the business, any liquid assets, such as cash, can be used to offset a part of the total debt and reduce the amount of net debt they will have to take on.
A company’s total debt is all the money owed to lenders or creditors. It includes both short-term and long-term debts. It’s also sometimes known as liabilities- money that must be paid back to others.
Who Uses Enterprise Value?
As mentioned, EV is a primary valuation method in mergers and acquisitions. This valuation technique enables investment bankers to compare companies and determine whether merging with or buying another company would benefit their clients. Although often seen solely in the M&A context, EV is utilized in multiple calculations throughout accounting and corporate finance. For instance, it’s used in ratios against EBITDA to compare companies from a unique angle.
EV, therefore, serves not only investment bankers but also other professionals, mostly in the finance sector. Its importance lies in providing a quick and effective tool for assessing the worth of a company and its potential for growth and profitability in the future.
Example For Enterprise Value Calculation
Let’s use an imaginary company as an example to understand how to calculate enterprise value. The enterprise value of a company is constantly changing due to fluctuations in stock prices. It means the EV and market cap at 11 am may differ from 6 pm. With details from the company’s current market information and balance sheet, we gather the following data:
- In-hand cash: $15,000
- Accounts receivable: $10,000
- Checking and savings account (total amount): $100,000
- Short-term debts: $30,000
- Accounts payable: $10,000
- Inventory value: $75,000
- Cost/share: $4.37
- Outstanding shares: 5,000
- Long-term debts: $250,000
EV of a company is comprised of three components – total debt, cash, and market cap. Hence, we must consider and group each component to determine the EV.
In terms of cash, this includes inventory, accounts receivable, checking accounts and savings accounts, as well as physical cash. Here, the company holds a total of $200,000 in cash.
Total debt means the total of long-term and short-term debts as well as any accounts payable, the company might have incurred. The total debt for this particular company is $290,000.
Finally, the company’s market cap can be calculated by multiplying the number of shares x cost/share. According to that, the company’s market cap is $21,850.
What Are The Limitations Of Enterprise Value?
Enterprise value is an important metric, but it has a few limitations. After all, EV can only give us an indication of the cost to purchase a company in its entirety, which may not be the most accurate measure when comparing companies in different industries. For instance, debt is often heavily used in capital-intensive industries such as gas and oil to fund growth. So, in such cases, EV can be distorted when comparing companies since the debt could have been used to purchase assets.
Besides, EV signals the cost of acquiring a business in theory. However, in actuality, companies are usually sold at a premium, especially when they’re profitable and have been experiencing growth. Therefore, enterprise value is the least amount of money one must pay.
Finally, determining enterprise value might be tricky. That’s because while market cap can be easily obtained, debt may not always be reported as accurately.
How To Show Enterprise Value Skills On Your Resume?
You can demonstrate your knowledge of business valuation methods, such as enterprise value, in your resume by noting it in the skills section. Additionally, if you have used EV in a prior work or internship experience, mention that within the job description as well.
However, if you don’t have any professional experience with EV yet, use your cover letter to talk about any personal experiences with it, such as a large project you completed that made you compare companies using EV or other valuation methods. It’ll show employers your enthusiasm for this skill which is beneficial for any business-related career path.
The Bottom Line:
Enterprise value is a metric used to estimate the total value of a company. It’s usually employed by other companies when they’re looking into mergers or acquisitions. Investors also use it to evaluate stocks and understand the size and worth of their investment.
Despite some limitations, EV provides important insights into a company’s financial health and worth. It’s a great way to compare the size of a business against others in the same industry and can also reveal potential risks if a company has taken on too much debt relative to its available cash reserves.
What is enterprise value vs. market value?
Enterprise value is a company’s overall worth, while market value refers to the price of its shares on the stock exchange. Market capitalization is the aggregate value of all shares traded on the stock market.
Can enterprise value be less than equity value?
Yes, enterprise value can be less than the equity value for companies that have more cash on hand than their debt obligations.
Why do businesses deduct cash from enterprise value?
Essentially, enterprise value measures what it would cost to acquire a business. So, if a company has a lot of cash, that amount would be transferred to the new owners as part of the acquisition process. Deducting that cash from the enterprise value helps bring down the acquisition cost, making it more attractive to potential buyers.
Why do businesses use Enterprise Value?
Businesses utilize enterprise value when considering the potential cost of purchasing another company. It’s especially helpful when the two companies have different capital structures. EV considers more than just outstanding stock and adds debt to the equation while subtracting cash, thus allowing businesses to accurately assess how much a company is worth.