The enterprise value (EV) includes measuring the total value of the company. It includes the company’s market capitalization and any cash on the balance sheet, as well as short-term and long-term debt.
Definition and Examples of Enterprise Value
Enterprise value is a calculation that represents the company’s total expenses assuming a single company will be acquired. For a publicly traded company, this means purchasing all shares of the company, making it private.
How to Calculate Enterprise Value
You can calculate enterprise value by adding the company’s market capitalization, preferred shares, and the company’s outstanding debt, and then subtracting the cash and cash equivalents on the balance sheet.
Understanding the Components of Enterprise Value
To understand enterprise value, you need to understand what each part of this framework represents.
Market capitalization: A name that means the number of common shares multiplied by the current share price.
Preferred shares: Although considered equity, preferred shares can function as either equity or debt, depending on the nature of the individual issue.
Debt: Once you purchase a company, you will also be responsible for its debts.
Cash (and cash equivalents): Once you buy the business, you can own any cash sitting in the bank. In fact, this reduces your acquisition cost. For this reason, it should be subtracted from the other components when calculating enterprise value.
How Enterprise Value Works
Enterprise value can be used to understand the value of investing in a company compared to its competitors. Some investors, especially those who subscribe to a value investing philosophy, will look for companies that generate a lot of cash relative to their enterprise value. Companies that fall into this category are likely to require little additional reinvestment.
However, there are downsides to using enterprise value as the sole method for evaluating a company. A large amount of debt, for example, can make a company look less valuable, even when that debt is being used appropriately.
Companies that require a lot of equipment, for example, often carry a lot of debt, but this is something that their competitors also do. For this reason, it’s best to use enterprise value to compare companies within the same industry, where their assets should be utilized in similar ways.
Source: https://www.thebalancemoney.com/calculating-the-enterprise-value-of-a-company-357495
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