Enterprise value: What it is, how to calculate it, and its purpose
At a glance:
• Enterprise value represents a company's total value, taking into account both its equity and its debt but excluding its available cash*;
• It is a key indicator used in company valuations, both in portfolio management and in the context of mergers and acquisitions, making it possible to compare businesses with different financing structures;
• To get a balanced and accurate picture, it should be analysed alongside other financial metrics, such as equity value and cash flows.
* For the sake of simplicity, we have excluded other items from this analysis, such as minority interests or preference shares.
Which is worth more? A company with high business value and significant debt, or a smaller company with no financial liabilities?
When evaluating a company, it can be tempting to focus solely on its share price or equity. However, this approach doesn’t provide a complete picture. To understand the true economic value of a business, it is important to consider not only the assets owned by the shareholders, but also the company’s financing.
This is where the concept of Enterprise Value comes in, which is a key metric in financial analysis and company valuation.
This article explains what Enterprise Value is, how it is calculated, and how it is used, helping you to understand the concept clearly and firmly.
What is Enterprise Value?
Enterprise value is the total value of a company. Unlike other metrics, it considers not only the value of equity, but also financial debt and available cash.
In practical terms, enterprise value is the theoretical cost of acquiring a company in its entirety, including both its debt and its cash reserves. For this reason, it is a widely used tool for analysing mergers and acquisitions, valuing companies, and comparing businesses in the same sector.
How is Enterprise Value calculated?
Enterprise value is calculated using a relatively simple formula:
Enterprise value = Equity value + Net debt
where equity value is the value of a company’s equity and net debt is total financial debt minus cash and cash equivalents.
For listed companies, equity value is typically determined by market capitalisation, which is the number of shares multiplied by the price per share. Net debt is added to this figure to obtain the enterprise value.
Enterprise Value vs. Equity Value: What’s the difference?
Although both are related, enterprise value and equity value measure different aspects of a company’s value.
• Enterprise value: it reflects the total value of a business, including equity and debt but excluding available cash;
• Equity value: it represents the value that belongs to shareholders after deducting debt.
Therefore, two companies with the same equity value may have significantly different enterprise values if they have different levels of debt. For those evaluating the company as a whole, enterprise value is the most appropriate metric to use.
The benefits of Enterprise Value
Enterprise value is a key metric in financial analysis, providing many benefits when it comes to evaluating companies and investment opportunities. This is what this indicator can do:
Evaluate the total value of the business
Enterprise value provides a more complete (and realistic) view of a company's value by considering both equity and debt simultaneously.
Compare companies with different financing structures
Enterprise value provides a more accurate comparison of companies within the same sector by eliminating the distortions associated with their financing, regardless of their different levels of debt.
It provides the basis for financial multiples
Analysts and investors widely use indicators such as EV/EBITDA or EV/EBIT, which make it possible to evaluate companies consistently and in a comparable way.
For example, the EV/EBITDA ratio compares a company's enterprise value with its EBITDA (earnings before interest, taxes, depreciation and amortisation), i.e. their operating profits before these factors are taken into account. This ratio provides an indication of how much the market is willing to pay for the company's operating performance, regardless of its capital structure or accounting policies.
By contrast, the EV/EBIT expresses enterprise value in relation to EBIT (earnings before interest and taxes), which is equivalent to operating profit after depreciation and amortisation. This indicator provides a more conservative assessment of operating performance and is particularly useful in sectors where significant investment in fixed assets is commonplace.
Limitations of Enterprise Value
Although enterprise value is relevant, it has limitations that must be taken into account when interpreting it.
Dependence on the quality of financial information
The calculation of enterprise value depends on the accurate identification of debt and cash position of the company. Any errors or inconsistencies in these values could distort the final result.
It does not directly reflect the profitability of the investment
Although the enterprise value indicates how much the business is worth, it does not assess whether this value will generate attractive returns for investors. For this reason, it should be analysed alongside profitability metrics.
Sensitivity to changes in the capital structure
Even if the company’s operations remain stable, changes in debt or cash can significantly alter enterprise value.
A complementary analysis is needed
Enterprise value alone does not provide a complete overview of a company’s risk or growth potential. Its usefulness increases when it is incorporated into a wider financial analysis.
Does enterprise value always accurately reflect a company’s true value?
Not always. Enterprise value is an estimate based on financial data. In the case of listed companies, it is also based on market values that reflect expectations and economic conditions.
In the case of unlisted companies, enterprise value is determined by financial valuations based on assumptions and projections. Even small changes to these assumptions can have a significant impact on the calculated value.
For this reason, enterprise value should be considered an analytical benchmark rather than a definitive or absolute value.
Other relevant indicators in investment analysis besides Enterprise Value
Enterprise value is most effective when analysed alongside other financial metrics, providing a more comprehensive assessment of the investment.
Below are other relevant indicators to take into consideration, which will help you to make an informed decision:
Equity value
This represents the value of the company’s equity, i.e. the shareholders’ portion once debt has been deducted. It demonstrates the impact of the financial structure on enterprise value.
Cash flow
It reflects the company’s ability to generate liquidity through its operations. This is essential for evaluating the business’s long-term viability and its capacity to reward investors and creditors.
Profitability
This measures the return generated in relation to the capital invested, making it possible to compare different opportunities and assess whether the company’s value is justified by the results obtained.
Risk
This is associated with uncertainty over future results and can be caused by factors such as indebtedness, the economic context or competition. As a general rule, the higher the risk, the higher the required return.
Enterprise Value: Invest with the support of Banco Carregosa
In order to accurately analyse companies and consistently compare investment opportunities, a comprehensive grasp of enterprise value is required. However, it is only when it is integrated into a structured financial analysis that aligns with the investor’s objectives that it adds true value.
At Banco Carregosa, we help investors understand indicators such as enterprise value, incorporating them into robust, informed investment strategies that align with their risk profile. Talk to us to find out how you can transform financial analysis into sustainable investment decisions.
Enterprise Value: Frequently Asked Questions
Below are answers to the most common questions about enterprise value.
1. What does Enterprise Value mean?
Enterprise Value refers to the total value of the business, considering equity and debt, and excluding available cash.
2. Why does Enterprise Value include debt?
Because debt is part of the business financing. Whoever acquires a company also assumes its financial obligations, making debt relevant to the valuation.
3. What is the difference between Enterprise Value and market capitalisation?
Market capitalisation reflects only the value of equity. Enterprise Value is more comprehensive, as it also includes net debt.