Valuing a company can be quite complex. There are total assets, debts, cash flow, and so many more things to consider. But the Enterprise Value (EV) formula is the key that can help you unlock a company’s total valuation. 

What Is Enterprise Value ? 

Enterprise Value is a method of determining a company’s total value that considers more than just its market capitalization. The formula takes a more holistic approach by also considering the company’s equity and debt.

When considering a company’s value, most people immediately think of its market capitalization. This method was popularized by investors, both professional and retail, and it’s commonly used when evaluating a company’s market value. We hear about it in the news when reporters discuss the stock market, and we take it into account when interpreting a company’s financial position. 

However, market capitalization does not provide a holistic understanding of a company’s true value as it does not consider debts or any cash or cash equivalents on the company’s balance sheet. Therefore, it’s not the most accurate way to value a company financially.

What is the purpose of Enterprise Value?

Since the Enterprise Value formula solves for a company’s total value, it provides insights that are key to carrying out various business functions such as:

  • Financial analysis
  • M&A valuations
  • Capital restructuring
  • Investment and performance benchmarks
  • Debt and liquidity planning
  • Financial reporting

 

For example, let’s say your company is looking to acquire a vendor in order to lower production costs and have more control over your product pipeline. This requires understanding not only the value of the vendor’s shares, but also its assets and liabilities. By doing so, your acquisition team can offer the vendor a fair purchase price or walk away from a potentially unfair deal.

 

A company’s Enterprise Value is also used in multiples for comparing companies in various financial ratios such as:

  • Enterprise Value to Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA)
  • Enterprise Value to Earnings Before Interest and Taxes (EV/EBIT)
  • Enterprise Value to Free Cash Flow (EV/FCF)
  • Enterprise Value to Sales (EV/Sales)

These multiples serve as a way to compare companies and perform competitive analysis. For example by comparing your business to similar ones in the same industry. 

For CFOs, it’s critical to understand these multiples as they are often used for capital structuring decisions, M&A investments, to know how to rank investments, and much more.

What are the Components of the EV Formula?

Before breaking down the Enterprise Value formula, it’s essential to understand its different components, what they mean, and how some of them are calculated. These components are: 

Total Debt

In the context of Enterprise Value, Total Debt represents the sum of a company’s interest-bearing liabilities. In other words, it’s the total of a company’s short-term and long-term debts. 

If the market value of the company’s debt is unknown or unclear, then the book value of their debt replaces it instead.

Cash and Cash Equivalents

Now that we know how much a company owes, it’s time to consider how much the company owns. Cash and cash equivalents refer to liquid assets that a company holds. In other words, assets that can be quickly converted into currency to cover immediate needs.

These assets include:

  • Cash
  • T-Bills
  • Money market funds
  • Bonds
  • Certificates of deposit 

 

Equity Value (Market Capitalization)

A company’s equity value is also known as its market capitalization, which measures the total value of a company’s equity as assessed by the open market. 

The formula to solve for a company’s equity value is:

Share Price × Total Number of Fully-Diluted Outstanding Shares

Preferred Stock

In the Enterprise Value formula, preferred stock is typically held in the same regard as debt. That’s because, similar to interest on debt, the company has to pay dividends to preferred stockholders.

Non-controlling (Minority) Interest

The non-controlling interest in a company represents those parts of the business not owned by the parent company. In this instance, the parent company would be represented by whoever owns at least 50% of the subsidiary, but less than 100%.

The non-controlling interest is considered part of the Enterprise Value formula since the parent company reports all of the subsidiary’s performance in its consolidated financial statements despite not fully owning it.

Enterprise Value Formula

The Basic Formula for Enterprise Value

Market Capitalization + Market Value of Debt – Cash and Equivalents

The Extended Formula for Enterprise Value

Market Capitalization (Share Price × Number of Outstanding Shares) + Total Debt + Preferred Stock + Noncontrolling Interest−Cash and Cash Equivalents

How to Calculate Enterprise Value

Now that you know the components and the formula for Enterprise Value you can use it to calculate a company’s real valuation. 

Let’s for example assume that a company has:

  • A market value of $50 per share
  • 10 million outstanding shares
  • $300 million in total debt
  • Preferred stock worth $30 million
  • A non-controlling interest of $20 million
  • Cash and cash equivalents worth $50 million

In that case you would first need to solve for the company’s market capitalization using the market cap formula:

$50 (share price)  × 10 million (outstanding shares) = $500 million Market Capitalization

Now we can plug all the numbers into the equation and solve for it:

$500 million + $300 million + $30 million + $20 million − $50 million = $800 million 

Therefore, the company’s Enterprise Value (EV) would be $800 million.

Calculating Enterprise Value With ERP

Xledge is a cloud-based ERP specializing in automating accounting processes, streamlining financial operations, and connecting all aspects of a business in one place. As a category leader, our ERP system allows CFOs and accounting teams to manage complex financial operations precisely and easily.

Calculating and tracking your organization’s financial data can be complex and time-consuming. By leveraging XLedger’s data tracking capabilities and reporting dashboards, CFOs and accounting teams can gain quick and convenient access to key metrics required to solve formulas like Enterprise Value.

We invite you to take a product tour and explore all the features our world-class ERP offers. Free your finance team from tedious and repetitive accounting tasks and contact us today.

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