Enterprise Value: The True Value of a Company

Enterprise value is a valuation technique that is used in order to determine the approximate value of a company. Investors use this method to determine whether they should invest in a company or not. Here are the basics of enterprise value and how it works.

Enterprise Value

The enterprise value attempts to tell you how much money it would take to purchase a publicly traded company. Many people get this confused with the market capitalization of a company. Market capitalization is another commonly used metric to determine the value of the company. However, enterprise value takes the market capitalization approach one step further. It attempts to give you a much more accurate picture of the real value of the company.

Difference From Market Capitalization

In order to calculate the market capitalization of a company, you are going to take the number of shares that are outstanding in the market place and multiply it by the share price. The enterprise value takes the market capitalization and then add to that number the amount of debt. They would then subtract the amount of cash and cash equivalents on hand in the company. If an investor work to try to purchase a publicly traded company, they would have to pay extra for the amount of debt that the company has. Therefore, enterprise value is a little bit more realistic than market capitalization.

Ratios

In order to use the information that is provided from an enterprise value calculation, you have to compare it to something else. Just looking at the enterprise value of a company is not going to actually provide you with that much valuable information. In order to get anything out of it, you have to use ratios. The enterprise value of the company is commonly compared to the EBIT of the same company. This is going to give you a good comparison as to the value of the company in relation to the cash flow that it produces. By doing this, you are going to be able to see the effect of debt on the value of the company. If you just look at the enterprise value of two companies side-by-side, they might look extremely similar. However, one company could have a large amount of debt while the other company is debt-free. This means that you need to take a look at the big picture when using enterprise value instead of focusing solely on the number that it produces.

Using Enterprise Value

Enterprise value can be a valuable tool for an investor when they are trying to decide whether they should invest in a particular company or not. This can tell you a lot more about a company than a simple market capitalization calculation could. However, you do not want to put too much weight into this one calculation. You should look at many different factors of the company before deciding whether to invest in it or not.

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