Enterprise Value (EV) Formula: What It Is and How to Use It

The enterprise value (EV) formula measures the total value of a company, considering both its equity and debt. It reflects what it would cost to acquire the business, including adjustments for cash and debt, offering a more comprehensive view than market capitalization alone. The enterprise value formula is pretty simple: add a company’s market capitalization and its total debt, and then subtract its cash and cash equivalents. This metric helps investors and analysts evaluate a company’s overall worth and compare it with competitors. It is often used in mergers, acquisitions or when assessing growth potential. A financial advisor can also work with you to analyze investments.

What Is Enterprise Value and How Is It Used?

Enterprise value (EV) represents the full value of a business by accounting for both equity and debt, along with adjustments for cash. Unlike market capitalization, which only reflects the value of a company’s outstanding shares, EV factors in the cost of settling debts and subtracts cash reserves. This makes it a useful indicator for understanding the total resources required to acquire the business, giving potential buyers a clearer picture of its financial obligations.

EV is widely used in corporate finance because it provides a more balanced view of a company’s size and structure. It assists analysts in comparing companies across different industries or with varying debt levels.

It is also relevant in valuation multiples like EV divided by earnings before interest taxes depreciation and amortization (EBITDA) or EV/EBITDA, where it offers a way to assess profitability without being influenced by capital structures. Investors rely on EV when identifying acquisition targets or comparing competitors, as it reveals not just what a company is worth on paper but how its financial obligations affect that value.

Why Cash and Cash Equivalents Are Subtracted

Cash and cash equivalents, such as Treasury bills or short-term investments, reduce the net financial obligation of the company. Since these assets can be used to pay down debt or fund operations, they provide immediate liquidity, making them a necessary part of the calculation. Subtracting cash ensures that the EV reflects only the net obligations and value.

How to Calculate Enterprise Value

The enterprise value formula is straightforward:

EV = Market Capitalization + Total Debt – Cash and Cash Equivalents

To calculate EV, start by finding the company’s market capitalization, which is the share price multiplied by the number of outstanding shares. Then, add the company’s total debt, including both short-term and long-term liabilities. Finally, subtract cash and cash equivalents, since these assets could be used to pay down debt.

Let’s use as an example a company with 10 million shares trading at $50 each, which gives it a market capitalization of $500 million. The company also has $100 million in debt and holds $20 million in cash. Using the formula:

$500 million + $100 million – $20 million = $580 million

In this example, the enterprise value is $580 million. This means that if someone wanted to acquire the business, they would need to account for not only the equity value but also the debt, minus any available cash. This calculation provides a clearer view of the true cost to take over the company.

Enterprise Value vs. Equity Value

An investor comparing enterprise and equity value formulas.

Enterprise value and equity value measure a company’s worth from different perspectives. Equity value, similar to market capitalization, only reflects the value of a company’s outstanding shares. It shows how much shareholders’ equity is worth based on the stock price, making it useful for investors looking to understand their ownership’s market value.

On the other hand, EV provides a more comprehensive picture by including both debt and cash in the calculation. While equity value focuses on just the shareholders’ stake, EV reflects the full cost of acquiring the business, accounting for obligations like debt and subtracting available cash that could offset liabilities.

For example, a company with high debt will have an EV much larger than its equity value, signaling that potential buyers need to consider more than just the stock price. Companies with large cash reserves, on the other hand, might have a lower EV relative to equity value. Analysts and investors use equity value to assess a company’s market position, while EV is more relevant for evaluating mergers, acquisitions, and comparisons between firms with different financial structures.

Pros and Cons of Enterprise Value

Enterprise value offers a broad perspective on a company’s worth by factoring in debt, equity and cash. However, like any financial metric, it has both advantages and limitations. Understanding these can help investors and analysts use EV effectively in valuations.

Benefits of Enterprise Value

Comprehensive valuation: Provides a complete picture by accounting for both debt and cash, unlike market capitalization.
Cross-industry comparison: Useful for comparing companies with different capital structures across industries.
Profitability insight: EV-based ratios like EV/EBITDA assess profitability without being skewed by taxes or interest expenses.
Acquisition cost clarity: Helps potential buyers gauge the actual cost of acquiring a business, beyond stock value alone.

Drawbacks of Enterprise Value

Data dependence: Requires accurate, up-to-date information on debt and cash, which may not always be available.
Limited with hidden liabilities: Can be misleading for companies with off-balance-sheet liabilities or restricted cash reserves.
Less useful for small firms: Less effective for small businesses or industries where debt and cash are not major factors.
Market volatility impact: Equity value, a key component of EV, can fluctuate with market conditions, affecting valuation accuracy.

Bottom Line

Enterprise value offers a well-rounded measure of a company’s worth by incorporating both equity and debt while adjusting for cash. It provides insights into the total financial commitment required to acquire a business, going beyond what market capitalization reveals. EV proves useful in comparing companies with different financial structures and evaluating acquisition opportunities, offering a consistent framework for analysts and investors. However, like any metric, it has limitations, particularly when data is incomplete or financial structures are complex.

Investment Planning Tips

A financial advisor can help you create an investment portfolio for your needs and goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Be sure to get the highest return available on your liquid assets with SmartAsset’s comparison tool for savings account interest rates.