How To: Enterprise Value

Enterprise Value is a better financial metric for measuring the size of a business and the assets required to operate a business than the Market Cap.

I find the formula for Enterprise Value to be a little unintuitive at first.

You take:

Market Cap

+Debt

-Cash

= Enterprise Value

So why in the world do you ADD debt and Subtract Cash?

What we are trying to account for using enterprise value is the asset base of the business or capital structure. Capital structure refers to the mix of debt and equity that the company carries. If we are trying to assess what it takes to run the business, we need to take debt into account because debt can be used in the daily operations of the business.

Ok, so why should we subtract cash? Cash is good, right?

Yes. Subtracting cash offsets, the debt. Subtracting cash makes the business look cheaper from an EV standpoint.

Many people refer to enterprise value as the amount it takes to acquire a business. Buying debt can be unintuitive because people view debt as something with a negative value. But debt is both an infusion of spendable assets and liability in the future.

Think about buying a house from someone with a mortgage. They may only have 50K in equity in their house but 200K in debt. Yet you buy both the debt and the equity. The seller subtracts the cash they receive from the proceeds of the sale and walks away with the equity left over.

Companies with a lot of debt will have a higher enterprise value, making them look bigger and more expensive. For example, a company with a 100M market cap and 10M in earnings will have a P/E ratio of 10X But the same company with an Enterprise Value of 150M and 10M in earnings would have a ratio of 15X.

Enterprise value encompasses the hidden costs of running a business. However, it can also undercover hidden cash on a balance sheet and enterprise value can actually be less than market cap in some situations. I recommend the Acquirers Multiple by Tobias Carlisle for more reading about Enterprise Value.

Source: The Acquirers Multiple