Enterprise value – also known as Entity Value (EV) is used to describe the market’s value of a company.
More comprehensive than a simple market cap valuation, it is used in business valuation, accounting, portfolio management and more. To calculate enterprise value, you calculate the market cap of the company (equity value), add the total debt and then subtract cash and investments. When you buy a company, you also buy any cash that is available in the company. It’s almost like an instant rebate – you may pay for the total price, but you’ll be getting some of the money back immediately.
One of the possible uses of enterprise value is the comparison of companies with different capital structures. It is beneficial to look at the true value of a company and know if it is being undervalued. This can be especially important if a company is seeking investors, or if an investor is looking for investment opportunities that have a higher reliability rate.
Understanding enterprise value does not give a true indication of the overall financial health of a company. Taken in context with other financial reports, it can provide you with a clearer picture of the true value of a company, but should not be used as the sole measurement of the company’s worth.
If a company has a high debt load, the enterprise value can be used as a benchmark for an acquisition price. Regardless, the EV should be calculated to reflect similar time periods, allowing for a true capital average over a specific time. This also standardizes the operations of both buying and selling.
Consider this example: A house is listed for sale at $300,000. You borrow $200,000 from the bank, and make a $100,000 down payment. In this example, the value of the house ($300,000) is the enterprise value of the house –it is the market value of the home. Your equity in the house ($100,000) is the equity value in the house.
Finding the enterprise value of a company can be informative, but is not a standalone indicator of a company’s financial standings. You need to gather all the available reports to establish a true and clear picture of the company’s worth.