How does Enterprise Value work in a company?
Enterprise value, or EV, calculates a company’s worth for M&A purposes (M&A). Calculating enterprise value (EV) involves market capitalization (the value of a company’s publicly traded shares) plus total debt minus cash and other readily marketable assets.
The Enterprise Value Formula is a financial metric that takes into account the company’s equity and preference shareholders as well as its secured and unsecured creditors. It is more common in situations where one company acquires another or where two or more organizations merge to create synergy.
Enterprise Value (EV) Formula and Calculation
EV=MC+Total Debt−C
Where:
MC = To calculate a company’s market cap, multiply its current stock price by its total number of outstanding shares.
Total debt = when you add up all of your debts, both short and long-term, that’s how much you owe.
C = The term “C” refers to a company’s “cash and cash equivalents,” which are its liquid assets.
What Does EV Tell You?
Many people believe that enterprise value (EV) is a more accurate reflection of a company’s worth than market capitalization. Because of these distinctions with EV, investors and other stakeholders can learn how much money would be required to acquire a business.
In addition, a company’s EV might be negative if its cash and equivalents are worth more than its market capitalization plus its loans. Too much idle money indicates that a company is not using its resources. Cash surpluses can be put to various uses, including debt reduction, stock buybacks and dividends, business growth and development, infrastructure upkeep and improvement, compensation increases for management and staff and more.
Why Does This Matter for Your Business?
Calculating enterprise value is useful in many contexts, including the pursuit of acquisitions and the evaluation of stock-based purchase bids. It’s a fundamental idea for figuring out valuation multiples, too. As an example, the enterprise value (EV) to earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple is frequently used to assess the performance of distinct but comparable organizations. If you want to learn more about how to implement EV in your business, we recommend reading Enterprise Value-To-EBITDA (EV/EBITDA) and How do you Calculate Your Enterprise Value.
How to Use Enterprise Value as an Acquirer?
Enterprise value provides insight into the debt and short-term assets of a public firm, both of which may affect a potential buyer’s offer.
Think about a scenario where you’re deciding between two publicly traded companies, both of which are equally appealing acquisition targets. Since Company A has a higher market cap of $230 million than Company B of $200 million, a premium of $30 million should be expected. While neither firm has any debt, the enterprise value formula indicates that Company A has $40 million in cash reserves and Company B has $10 million in cash reserves. The worth of their respective businesses is thus a tie. Nonetheless, you could still make a case for giving $30 million more to Company A because its financials would justify it with a higher value on balance sheet.
How to Use Enterprise Value When Evaluating Acquisition Offers?
Just about here is when things start to get exciting. When deciding between many acquisition proposals, it is essential to compare the value of the stock offered by each possible buyer to the enterprise value of the target company. In particular, the enterprise value would grow if the acquiring firm had a lot of debt and very little cash on hand. However, companies in sectors that require a lot of capital are more likely to be heavily leveraged than those in less capital-intensive sectors.
If the acquirer bases its acquisition offer on the face value of its shares, you should negotiate for a higher number of shares or a combination of shares and cash to attain the deal in terms of the buyer’s enterprise value.
Limitations of EV
As mentioned before, EV takes into account all debt, but it’s also important to think about how management is planning to put that money to use. Capital-intensive sectors like the oil and gas industry, for instance, frequently have high levels of debt to fuel expansion. It would have been possible to finance the purchase of machinery and facilities using the borrowed funds. In this way, the EV can be biased when comparing businesses in different sectors.
If the targeted company is in the process of merging or being acquired, this factor is crucial to think about. Because the acquiring firm must take into consideration the debt it is assuming as a result of the merger, this is the case. Investors can use this data to predict the combined firm’s future performance.
Any financial statistic is only as useful as its ability to be compared to other metrics used by companies in the same industry.
Calculate Enterprise Value with Eqvista
By using valuation multiples tools used for financial measurement, which help compare one financial metric to another. We do a valuation to make it easier to compare different businesses. Get help from a business valuation expert. When deciding what a company is worth on the fair market, experts use different valuation methods to look at several factors. Our NACVA-certified valuation team provides you with support throughout the process. Get in touch right now to set up a quick discussion.
