Formula for Enterprise Value: How a Business Uses EV

The total enterprise value (EV) of a company is the total value of a company including its market capitalization and market value of debt minus the company’s cash balance (or the balance of cash equivalents). It can serve as a capital-intensive financial modeling metric to determine the real-world market price of a company’s balance sheet, particularly to a person or entity interested in acquiring that company.

An acquirer or financial analyst might use this sort of formulation in the situation of mergers and acquisitions to get an accurate business valuation for a theoretical takeover price (the price of buying out the total value of the company). This market price includes subsuming the present value of a company’s outstanding debt, which is one reason why a company’s enterprise value can be more accurate than its market capitalization value alone. Taking the amount of debt into account leads to a firm value that wouldn’t otherwise be attained.

Market capitalization (or market cap) is the equity value of a company—in other words, the value of a company’s shares without taking the company’s debt into account. The market value of equity is determined by taking the current share price (or current stock price) to buy into a company and multiplying it by the number of outstanding shares available.

Keep in mind that many companies provide both common stock and preferred stock as marketable securities for shareholders. Common shares are generally more volatile but allow their holders to weigh in more on company matters. Preferred shares are usually more secure, intertwined with the total debt of a company, and preclude holders from voting on company decisions.

While market capitalization value can be useful in its own right, calculating for market cap value instead of enterprise value can provide the formulator with different capital structures.

Arriving at an enterprise value calculation is fairly straightforward. You must add the market capitalization (MC) to the net debt (D) of a company and then subtract the cash or equivalent reserves (C) that function as liquid assets. Written out mathematically, it looks like this: EV = MC + D - C.

To expand a little further on this equation, consider that market capitalization (MC) includes both common shares (CS) and preferred shares (PS). Similarly, both the short-term and long-term debt of a company can be supplemented with the minority interest (MI), as this is generally included in a company’s financial statements. Minority interest (MI) is the amount of a company owned by other entities, including all relevant free cash flow between the company and those entities—in other words, those to whom the company is indebted. Minority interest is also sometimes referred to as non-controlling interest.

Written to take all of this extrapolation into account, the equation can be written as: EV = CS + PS + MI - C.

Enterprise value, or EV, can be useful if you’re trying to determine a company’s value. It becomes even more useful when you begin comparing it to other metrics. Here are five ways to use an EV calculation by comparing it to other business valuation figures:

1. 1. Compare EV to book value. To determine the book value of a company, you measure asset by asset rather than looking at a lump amount. Comparing book value against enterprise value can enable you to take a more granular view of the company’s financial health.
2. 2. Compare EV to EBIT. Comparing enterprise value against earnings before interest and taxes—or abbreviated, EBIT—will display how the stock prices and debts of a company minus their cash reserves are holding up when it comes to their profits. You can refer to this comparison as EV/EBIT.
3. 3. Compare EV to EBITDA. Like an EV to EBIT ratio, EV/EBITDA compares a company’s enterprise value and its earnings. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. In this case, the earnings are factored to exclude interest and taxes as well as depreciation and amortization.
4. 4. Compare EV to sales. The EV/sales ratio enables you to view how a company’s valuation stacks up against its sales metrics. If sales are going well at the same time a company’s assets are riding high, debts are held in check, and cash reserves are plentiful, you can generally expect a good EV/sales ratio.
5. 5. Compare EV to the price-to-earnings ratio. A price-to-earnings (PE) ratio, or P/E ratio, tracks a given stock’s price against how much it’s earning. Taking this into account can provide you an even more in-depth look at a company’s market cap and, as a result, a more well-rounded look at its enterprise value as well.

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