Enterprise Value (EV) Formula and What It Means (2024)

What Is Enterprise Value (EV)?

Enterprise value (EV) measures a company’s total value. Its calculation includes not only the market capitalization of a company but also short-term and long-term debt, as well as any cash or cash equivalents on the company’s balance sheet. It is often used as a more comprehensive alternative to market capitalization when valuing a company.

How Enterprise Value (EV) Works

Enterprise value (EV) differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm’s value. EV tells investors or interested parties a company’s value and how much another company would need if it wanted to purchase that company.

A company’s EV can be negative if the total value of its cash and cash equivalents surpasses that of the combined total of its market cap and debts. This is a sign that a company is not using its assets very well—it has too much cash sitting around not being used. Extra cash can be used for many things, such as distributions, buybacks, expansion, research and development, maintenance, employee pay raises, bonuses, or paying off debts.

Enterprise value uses figures from a company’s financial statements and current market prices. The components that make up EV are:

• Market cap: The total value of a company’s outstanding common and preferred shares
• Debt: The sum of long-term and short-term debt
• Preferred equity: Preferred shares of equity need to be included as well since they are claimed on the company's equity not included in market capitalization.
• Minority interest: The equity value of a subsidiary with less than 50% ownership
• Cash and cash equivalents: The total amount of cash, certificates of deposit (CDs), drafts, money orders, commercial paper, marketable securities, money market funds, short-term government bonds, or Treasury bills that a company possesses

Formula and Calculation

Enterprise value is the sum of a company's market capitalization and any debts, minus cash or cash equivalents on hand.

$\begin{aligned} &EV=MC+Total~Debt-C\\ &\textbf{where:}\\ &MC=\text{\small Market capitalization; equal to the current stock}\\ &\text{\small price multiplied by the number of outstanding stock shares}\\ &Total~debt =\text{\small Equal to the sum of short-term and}\\ &\text{\small long-term debt}\\ &C=\text{\small Cash and cash equivalents; the liquid assets of}\\ &\text{\small a company, but may not include marketable securities}\\ \end{aligned}$​EV=MC+TotalDebt−Cwhere:MC=Marketcapitalization;equaltothecurrentstockpricemultipliedbythenumberofoutstandingstocksharesTotaldebt=Equaltothesumofshort-termandlong-termdebtC=Cashandcashequivalents;theliquidassetsofacompany,butmaynotincludemarketablesecurities​

To calculate market capitalization—if not readily available online—you would multiply the number of outstanding shares by the current stock price. Next, total all debt on the company’s balance sheet, including both short-term and long-term debt. Finally, add the market capitalization to the total debt and subtract any cash and cash equivalents from the result.

Financial Ratios That Use Enterprise Value

Enterprise value is used as the basis for many financial ratios that measure the performance of a company. For example, the enterprise multiple contains enterprise value. Itrelates the total valueof a company from all sources to the earnings before interest, taxes, depreciation, and amortization (EBITDA).

EBITDA measures a company’s ability to generate revenueand is used as an alternative to simple earnings ornet incomein some circ*mstances. It is usually positive even when earnings per share (EPS) is not.

EBITDA, however, can be misleading because it strips out the cost of capital investments like property, plant, and equipment. Another figure, EBIT, can be used as a similar financial metric without the drawback of removing depreciation and amortization expenses related to property, plant, and equipment (PP&E).

Enterprise Multiple (EV/EBITDA Ratio)

The enterprise multiple (EV/EBITDA) metric is used as avaluationtool to compare the value of a company and its debt to the company’s cash earnings, less its non-cash expenses. As a result, it’sideal for analysts andinvestors looking to compare companies within the same industry.

The enterprise multiple is useful when:

• Comparing firms with different degreesof financial leverage (DFLs)
• Valuing capital-intensive businesses with high levels ofdepreciation and amortization
  

However, the enterprise multiple also has a few drawbacks. If working capital is growing, EBITDA will overstate cash flows from operations (CFO or OCF). Further, this measureignores how different revenue recognition policies can affect a company’s OCF.

Because free cash flow to the firmcaptures the number of capital expenditures (CapEx), it is more stronglylinked with valuation theory than EBITDA. EBITDA will be a generally adequate measure ifcapital expenses equal depreciation expenses.

EV/Sales Ratio

Another commonly used multiple for determining the relative value of firmsis the enterprise value-to-sales ratio, orEV/sales.EV/sales is regarded as a more accurate measure than the price/sales ratio since it considers thevalue and amount of debt that a company must repay at some point.

A company with a lower EV/sales multiple is often seen as more undervalued and therefore more attractive.The EV/sales ratiocan be negative when the cash held by a company is more than the market capitalization and debt value. A negative EV/sales implies that a company can pay off all of its debts.

Enterprise Value vs. Market Cap

Why doesn’t market capitalization properly represent a firm’s value? It leaves a lot of essential factors out, such as a company’s debt and cash reserves. Enterprise value is a modification of market cap, as it incorporates debt and cash for determining a company’s value.

Imagine two identical widget manufacturers, Company A and Company B, have the same stock price of $4.32 per share. Each has 1 million outstanding shares with a market cap of $4.32 million.

Now, imagine Company A has $500,000 in cash and cash equivalents and $250,000 in total debt. Its EV (total worth) is:

($4.32 per share x 1 million shares) + $250,000 - $500,000 = $4.07 million

Company B, on the other hand, has $1 million in cash and $250,000 in debt. Its EV is:

($4.32 per share x 1 million shares) + $250,000 - $1,000,000 = $3.57 million

The companies looked identical when using just their market capitalization. However, once the EV takes into account both debt and cash, the value of Company A is significantly higher.

EV vs. P/E Ratio

The price-to-earnings ratio (P/E ratio) is a ratio for valuing a company that measures its current share price relative to its earnings per share (EPS).The price-to-earnings ratio is sometimes known as theprice multipleor the earningsmultiple.

The P/E ratio doesn’t consider the amount of debt that a company has on its balance sheet. EV includes debt when valuing a company and is often used in tandem with the P/E ratio to achieve a comprehensive valuation.

Limitations of EV

EV includes total debt, so it’s essential to consider how management utilizes that debt when valuing a company. For example, capital-intensive industries such as the oil and gas industry typically carry significant amounts of debt, which is used to foster growth in ways like purchasing a plant and equipment.

In a less capital-intensive industry, however, high levels of debt could indicate that a company is unable to generate enough revenue to cover the costs of basic operations. As a result, the EV can be skewed when comparing companies across industries.

If the company being looked at is undergoing a merger or acquisition, the acquiring company will need to account for the amount of debt it is taking on in the merger. Investors can use this information to evaluate what the merged companies will look like in the future.

As with any financial metric, it’s best to compare companies within the same industry to better understand how the company is valued relative to its peers.

Example of Enterprise Value

The formula for EV is the sum of the market value of equity (market capitalization) and the market value of a company’s debt, less any cash. A company’s market capitalization is calculated by multiplying the share price by the number of outstanding shares.

The net debt is the market value of debt minus cash. A company acquiring another company keeps the cash of the target firm, which is why cash needs to be deducted from the firm’s price as represented by the market cap.

Let’s calculate the enterprise value for Macy’s (M), using data from their Form 10-K.

For its 2023 fiscal year, Macy’s recorded the following: