Enterprise Value, also sometimes called “EV,” is a measure of a company’s total business value. EV is the theoretical price for a company if it were to be bought, and because EV accounts for a company’s debt and cash, it is considered a more accurate representation of a firm’s value than many other valuation methods.
Enterprise Valuation Calculation
Enterprise value is calculated as the market capitalization (share price multiplied by the number of shares outstanding), plus debt, minority interest, and preferred shares, minus total cash and cash equivalents.
EV = market value of common stock + market value of preferred equity + market value of debt + minority interest – cash and investments.
Why Enterprise Value is Important
Enterprise value is a fundamental economic measure that reflects the total value of a business. EV is used regularly in business valuation, accounting, portfolio analysis, financial modeling, and risk analysis. While many investors will look exclusively at market capitalization to value a company, in most cases, EV is a better representation of actual value.
Market capitalization and P/E ratios are other valuation methods commonly used to calculate the value of a business, but they only take into account a company’s outstanding equity (defined as the share price multiplied by the number of outstanding shares). Conversely, enterprise value considers several other important financial factors.
In order for a buyer to purchase a company outright, it would have to assume responsibility for the acquired company’s debt, and similarly, would also receive all of the company’s cash. Both debt and cash have a large impact on a company’s value, making enterprise value a more accurate representation of a company’s ongoing operations.
How Do Investors Use EV?
Stock market investors may use EV to compare returns between two similar companies on a risk-adjusted basis. But it’s important to understand equity investors often have trouble assessing EV because they may not have access to the current market value of the company’s debt.
Is Enterprise Value Relevant to the Small or Medium Business Owner?
If you own a small or medium size business, the Enterprise Value concept is very important to understand, especially in the event you plan to sell your business and intend to sell under the stock method. When purchasing a business under the stock method of acquisition, the cash and debt on the company’s books remain with the buyer. Understanding what your business is worth at an operational level, within the context of its capital structure, will give you an edge in negotiating a sale. It also can help you to plan how to continue to grow your business in the coming years.
While many investors will look exclusively at market capitalization to value a company, in most cases, EV is a better representation of actual value.
Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.
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