Understanding enterprise value formula is essential for accurately valuating a business. Enterprise value (EV) is a measure of a company’s overall value and represents the value of a company as a whole. It allows investors to quickly assess the financial health and potential of a business. It is also used by lenders to assess the risk of lending money to a company. The calculation of enterprise value can be difficult to understand and is often disregarded as too complicated. This blog post provides a comprehensive guide to understanding and calculating the enterprise value formula. It explains the components of the formula, how to calculate it, and how it can be used to assess a business. By the end of this post, you will have a clear understanding of how to calculate enterprise value formula and be able to use it to your advantage.
Calculating the Enterprise Value of a Firm
What is enterprise value?
Enterprise value is the total value of a company. If a business professional wants to make an offer to buy it, they typically use the enterprise formula to calculate the total cost of the business. Enterprise value includes:
Many investors believe that enterprise value is a more thorough assessment than simple market capitalization and that it provides a more accurate picture of a company’s worth. Enterprise value provides a more accurate valuation by factoring in debt and cash because a potential takeover would require paying off a company’s debt.
What is the enterprise value formula?
The enterprise value formula is a straightforward formula for estimating the total value of a company. Here is the formula:
Market capitalization plus total debt minus cash and cash equivalents equals enterprise value.
The formula aids a prospective purchaser or investor in understanding the debts and overall worth of the business for a more accurate price evaluation.
How to calculate enterprise value formula
The enterprise formula plays a significant role in assessing a company’s value. The formula to calculate the enterprise value of any company is as follows:
1. Determine the companys market capitalization
The total market value of a company’s outstanding shares of stock is what is known as its market capitalization, also referred to as its market cap. This demonstrates to consumers or business owners the market value of the company’s stock. The number of outstanding shares multiplied by the current stock price will yield this lump sum. For instance, if Hillsdale Bank has 40 million shares that are outstanding and each cost $35, the market capitalization is $1,400,000,000.
2. Calculate the total debt of the company
Debt is important to consider when analyzing a company’s financial picture because it informs investors and business owners of the amount of debt the company must pay off before turning a profit. The sum of the company’s outstanding short-term and long-term debt balances must be used to determine its debt. This can apply to loans for equipment, vehicles, real estate, or businesses. You can estimate Hillsdale Bank’s total debts using the same example:
Short-term debts: $120,000
Long-term debts: $824,000
Total debt: $944,000
3. Add the companys cash and equivalents
The company’s most liquid assets are cash and cash equivalents. Cash is any currency the business has on hand, as well as any investments, treasury bonds, and other assets it can quickly sell to raise money. To determine the total, add up each business account, investment, and bond. For example:
Cash: $4,000,000
Cash equivalents: $2,550,780
Total: $6,550,780
4. Add market capitalization values to the companys total debt and subtract cash and cash equivalents
You can enter your three key values into the formula once you’ve decided on them to produce a total enterprise value. First, start with your market capitalization values and debt. Using the aforementioned illustration, you can establish that Hillsdale Bank has a total debt and market capitalization of $1,400,944,000. The final amount is then calculated by deducting the total cash and cash equivalents held by the company. In this case, Hillsdale Banks enterprise value is approximately $1,394,393,220.
Examples of enterprise value using the formula
The enterprise value formula can be made clearer by using examples. Examples from the real world can illustrate how debts and market capitalization look and how the debt structure of a company can impact its overall value. Here are some examples of the formula:
Example 1
Ohio-based Riversend Manufacturing creates steel products like couplers and other industrial tools and parts. A sizable portion of the business’s debt was just paid off, and Browlers Steel Inc. is making an offer to purchase the company. The CFO of the business determines the total value of Riversend Manufacturing utilizing the enterprise value formula:
Formula: $32,159,431 = $21,500,000 + $16,000,000 – $5,340,569 Market capitalization: $21,500,000 Total debt: $16,00,000 Cash and equivalents: $5,340,569
The companys total enterprise value is $32,159,431.
Example 2
The New Hampshire-based clothing company Acadian Clothing has a sizable amount of unpaid debt and little cash on hand. The owner of the company wants to sell the company in order to pursue other employment opportunities, so they determine the enterprise value to get a general idea of how much it is worth:
Formula: $7,185,000 = $4,000,000 + $3,250,000 – $65,000 Market capitalization: $4,000,000 Total debt: $3,250,000 Cash and equivalents: $65,000
The companys total enterprise value is $7,185,000.
Example 3
A Colorado-based company called Drakon Energy Drinks uses CBD in its energy drinks. With high share prices, a sizable amount of cash on hand, and little debt, the business will soon turn a profit. To help the CEO set goals for the upcoming year, the company’s CFO calculates the enterprise value and shares it with him:
Formula: $60,750,000 = $65,000,000 + $250,000 – $4,500,000 Market capitalization: $65,000,000 Total debt: $250,000 Cash and equivalents: $4,500,000
The companys total enterprise value is $60,750,000.
FAQs about the enterprise value formula
Despite being a crucial indicator of a company’s financial health and stability, enterprise value is a general formula that only considers a broad sum. Here are some frequently asked questions regarding enterprise value and the formula:
Can you calculate the enterprise formula on a spreadsheet?
The enterprise formula can be used with a calculator or a spreadsheet because it is so straightforward. You can make a column in a spreadsheet where the sheet will automatically add the sum of any numbers you enter by using the SUM feature. Incorporate the names of each cell you wish to add or remove into your own formula. An example of an enterprise formula in a spreadsheet would be: A1 + A2 – A3. The cell is represented by the letter, and its position in the column is indicated by the number.
Does an enterprise value formula show how a company uses debt?
Although you can learn a company’s debt structure from the enterprise formula, it doesn’t reveal how the company uses the debt. You may view debt incurred during a company acquisition as acceptable if it is used by the target company to finance investments and growth. Getting more details on debts can help you understand the advantages or disadvantages of the purchase.
Are comparisons with competitors effective for accurate enterprise values?
Comparing a company to its rivals in the industry is crucial to understanding its position within that sector. Once you have determined a company’s enterprise value, compare it to the values of a number of its top rivals. You can also examine the companies’ debt utilization and total amount of outstanding debt. This reveals whether you’re making a wise investment and whether the business manages its debt responsibly.
Is debt an important figure in the enterprise value of a company?
When determining a company’s equity, you deduct its debt from its assets rather than adding it. But when it comes to enterprise value, debt is crucial to the company’s overall value from an investment perspective. When purchasing a company, an investor also purchases the company’s debt. The seller includes debt in the total price to buy the business because they want to be paid for their company as well as their debts.
FAQ
Why is enterprise value calculated?
Market capitalization plus preferred stock plus outstanding debt plus minority interest minus cash and cash equivalents is the formula for calculating enterprise value.
How do I calculate enterprise value in Excel?
In addition to a company’s market capitalization, short- and long-term debt, and any cash on the balance sheet are all taken into account when calculating enterprise value. Numerous financial ratios that assess a company’s performance are based on enterprise value.
How do you calculate enterprise value on a balance sheet?
- Equivalent Value = 25,000 + 0 + 5,000 – 100.
- Equivalent Value = $29,900.
