The enterprise value formula is a financial metric used in business valuation. It is a type of market prospect ratio that is commonly used by analysts and investors to gauge a company before a takeover. An investor or financial analyst might use this enterprise value formula in the situation of mergers and acquisitions to get an accurate business valuation for the price of buying out the total value of the company.
Here, we will look at the definition, formula, and calculation examples of enterprise value.
What is enterprise value (EV)?
Enterprise value can be defined as the total value of a company or the effective cost of buying a company. It includes the market capitalization (current share price) and the cost to pay off debt. It is one of the fundamental metrics used in business valuation, financial analysis, accounting, portfolio analysis, and risk analysis.
Enterprise value is an economic metric reflecting the market value of a company. It looks at the entire market value of a company rather than just the equity value. This means that all ownership interests and asset claims from both debt and equity are included when calculating it. The enterprise value (EV) is also known as total enterprise value (TEV) or firm value (FV).
Enterprise value formula
The enterprise value formula (EV formula) is a financial metric that provides a much more accurate takeover valuation. This is because it includes debt in its value calculation.
Types
The enterprise value formula has two variations; a simple variant and an expanded variant.
Simple variant EV formula
The EV formula can be expressed as Enterprise value (EV) = [(Market capitalization + Total liabilities) – Cash and cash equivalents]
Where:
Market capitalization or market cap = The current stock price multiplied by the number of outstanding shares
Total liabilities = The sum of short-term and long-term debt
Cash and cash equivalents including marketable securities.
Expanded EV formula
The expanded enterprise value formula is: EV = [(Common shares + Preferred shares + Market value of debt + Minority interest) – Cash and equivalents]
Where:
EV = Enterprise value
Common shares = A type of security that represents ownership of equity in a company. Holders of common shares elect the board of directors and vote on corporate policies.
Preferred shares = Any share that can act as either equity or debt, depending upon the nature of the individual issue. A preferred share issue that must be redeemed at a certain date at a certain price is, for all intents and purposes, debt. Participating in preferred shares gives its shareholders the right to receive a fixed dividend and also share in a part of the profits. Convertible preferred shares are types of shares that can be exchanged for common shares. Nevertheless, the preferred share represents a claim on the business that must be factored into enterprise value.
Market value of debt = Total liabilities which are the short-term and long-term obligations of the company.
Minority interest = Non-controlling interest or interest of less than 50% in the company.
Cash and equivalents = Cash and cash equivalents including marketable securities.
Examples and calculations
Enterprise value being a measure of a company’s total value reflects the opportunistic nature of business and may change substantially over time because of both external and internal conditions. It is a popular metric used to value a company for a potential takeover. Therefore, financial analysts often use a comfortable range of enterprise value (EV) in their calculations.
Below are some calculation examples using the enterprise value formula:
Example 1:
Suppose a retail company has a market capitalization of $22.4 million, total liabilities of $104.7 million, and a cash balance of $8.4 million
EV = Market capitalization + total liabilities – cash and cash equivalents
Using the Enterprise value formula
EV = $22.4 million + $104.7 million – $8.4 million
The retail company’s enterprise value = $118.7 million
Example 2:
Consider the information below for a software company
| Items | Amount |
| Outstanding shares | 410 million |
| Short-term debt | $372 million |
| Long-term debt | $5.2 billion |
| Cash and cash equivalents | $1.58 billion |
| Share price close on: 1/6/2022 | $20.22 |
Based on the above, the company’s:
- Market capitalization or market cap = The current stock price multiplied by the number of outstanding shares = $20.22 x 410 million = $8.2902 billion
- Total liabilities = The sum of short-term and long-term debt = $372 million + $5.2 billion = $5.572 billion
- Cash and cash equivalents = $5.58 billion
Using the enterprise value formula = Market capitalization + total liabilities – cash and cash equivalents
EV = $8.2902 billion + $5.572 billion – $5.58 billion.
Therefore, the software company’s enterprise value = $8.2822 billion
Example 3:
Suppose a manufacturing company has the following details:
| Items | Amount |
| Common shares | $1,200,000 |
| Preferred shares | $300,000 |
| Total outstanding debt | $880,000 (This is the same as the market value of debt) |
| Minority Interest | $200,000 |
| Cash & Cash Equivalent | $965,000 |
EV = Common shares + preferred shares + market value of debt + minority interest – cash and equivalents
EV = $1,200,000 + $300,000 + $880,000 + $200,000 – $965,000
Therefore, the manufacturing company’s EV = $1,615,000
FAQs
How do you calculate enterprise value (EV)?
You can calculate enterprise value by adding a company’s market capitalization, and total liabilities together and then subtracting the cash and cash equivalents.
What does enterprise value (EV) tell you?
Enterprise value (EV) tells you the theoretical price that would need to be paid in order to fully acquire a company. Based on the components contained in its formula, it provides a much more accurate takeover valuation.
Why are the cash and cash equivalents subtracted in the enterprise value formula?
You would subtract the cash and cash equivalents because once you have acquired complete ownership of a company, the cash and its equivalents become yours.
What is the enterprise value formula?
Enterprise value (EV) = Market capitalization + total liabilities – cash and cash equivalents
Conclusion
The enterprise value formula can be used to understand the value of investing in a company as compared to its competitors, hence it is a popular figure among investors and analysts and is often used in financial ratios.
Enterprise value is a popular measurement of the total value of a company. It can be seen as the theoretical price that would need to be paid in order to fully acquire a company. Investors who are keen on a company’s value often look for companies that generate a lot of cash flow in relation to their enterprise value when they want to invest because companies that fall into this category are more likely to require little additional reinvestment after a takeover.
The con of using enterprise value is this, companies that require a lot of equipment such as production companies may have a lot of debt which they use for equipment purchases.
As a result, they may have a low enterprise value and might look less valuable when compared to companies in a different sector such as retail companies that use less equipment. This is why it is best to use enterprise value to compare businesses within the same industry since their assets and liabilities are likely to be in the same range.
Last Updated on November 6, 2023 by Nansel Nanzip Bongdap
Blessing's experience lies in business, finance, literature, and marketing. She enjoys writing or editing in these fields, reflecting her experiences and expertise in all the content that she writes.
