Enterprise Value Formula & Examples

What is Enterprise Value?

Enterprise Value (EV) is a way of measuring what a company is worth, and is often used by would-be acquirers. It is a closely related concept to market capitalization, except for a few key differences. Whereas market capitalization only looks at the company’s equity value, enterprise value also takes into consideration the company’s debt and cash. In this way, enterprise value provides a more holistic view of a company’s value.

Enterprise Value Formula?

The formula for calculating Enterprise Value is as follows:

Enterprise Value (EV) = Market Capitalization + Total Debt - Cash and Cash Equivalents

To better understand this formula, let’s dive into each of its components in more detail:

• Market Capitalization is the value of the company’s outstanding shares of stock. It is calculated by multiplying the share price by the total number of shares outstanding.
• Total Debt consists of the company’s short-term and long-term debt obligations.
• Cash and Cash Equivalents are cash and other assets that can be converted into cash very quickly, such as certificates of deposit, money market funds, or Treasury bills. The reason these are subtracted from Enterprise Value is that a potential acquirer could use these assets to help finance the purchase of the company.

The formula makes sense when you think of the company from the perspective of an acquirer. In a sense, it asks the question “What would I need to pay if I wanted to own this company free and clear of all debts?” In that scenario, you would need to pay for the shares themselves (as captured by the market capitalization), but once you own the company you could use the company’s cash and cash equivalents to help pay off its debts.

Expanded Formula for Enterprise Value

In some cases, the calculation of enterprise value might require a more nuanced approach, taking into consideration additional elements such as preferred equity and minority interest.

Enterprise Value (EV) = Market Capitalization + Total Debt - Cash and Cash Equivalents + Preferred Equity + Minority Interest

• Preferred Equity refers to any preferred shares that the company may have issued. These need to be included in the enterprise value because the owners of preferred shares will have a priority claim on the company’s assets. In other words, they would need to be paid off in the event of an acquisition.
• Minority Interest is included in enterprise value in situations where the company has partial ownership of one or more subsidiaries. In those situations, the enterprise value formula will often include the cost associated with buying out the remainder of those subsidiaries.

The inclusion of minority interest can be a bit confusing. Here again, it is helpful to take the perspective of someone considering acquiring the company. If the acquirer wants to have full control over the company and its subsidiaries, then he or she may need to budget for the cost of buying out the unowned portion of those subsidiaries’ shares. For example, if the company owns 80% of its subsidiaries, then the minority interest would reflect the cost of that additional 20%.

Real World Example of Enterprise Value

Let’s calculate enterprise value using a real-world example of Microsoft Corporation, using data as of their most recent annual 10-K filing (June 30th, 2023). As we move through the figures, be mindful of the different units being used (i.e. millions versus billions).

On June 30th 2023, Microsoft had a market capitalization of $2,535.66 billion. As of that time, we can see their Total Debt and Cash and Equivalents by looking at their June 30th 10-K filing:

For the Total Debt, we can see that they had long-term debt of $41,990 million and short-term debt (consisting of the “current portion of long-term debt”) of $5,247 million. Adding these together gives us $47,237 million.

For their Cash and Cash Equivalents, we have $34,704 million in assets that are explicitly described as “Cash and Cash Equivalents”. However, we also have “short-term investments” of $76,558. Individual analysts may vary in terms of whether or not to include those short-term investments when calculating enterprise value. The decision would typically depend on how quickly the short-term investments could be converted into cash.

To investigate this further, we can examine the notes to Microsoft’s financial statements to gain more insight into what exactly their short-term investments consist of. Specifically, on page 50 of their 10-K annual filing, we find that they “consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers.” This certainly meets our criteria for liquidity, so we can include these assets when calculating enterprise value. Therefore, our Cash and Cash Equivalents (including these short-term investments) is $111,262 million.

Putting these pieces together, we can calculate Microsoft’s enterprise value as follows:

Enterprise Value = $2,535.66 billion + $47,237 million - $111,262 million = $2,471.64 billion

Limitations of Enterprise Value

While the concept of enterprise value provides a useful definition of what a company is worth, there are certain limitations to be aware of:

• Volatility: Since enterprise value is based in part on market capitalization, it will fluctuate along with the company’s share price and shares outstanding.
• Quality of debt: The formula doesn’t differentiate between different types of debt, or the terms of the debt, such as its interest rates and risk profiles.
• Ignores certain items: The enterprise value simplifies the value of the company by not directly considering certain intangible assets or off-balance-sheet liabilities.
• Treatment of minority interest: Minority interest is not always included in the calculation, which can lead to inconsistencies when comparing enterprise values across companies and sectors.

As with all financial metrics, enterprise value has limitations, so analysts will need to use it carefully and in combination with other methods to have a complete and thorough understanding.

Enterprise Value vs. Market Capitalization

The market capitalization focuses exclusively on the shareholders' perspective, while enterprise value offers a more complete view, encompassing debt holders and other financial interests due to the addition of net debt, preferred equity, and minority interest.

Here’s the main differences in further detail:

• Enterprise Value (EV) represents the total value of a business, including its equity value (also known as its market capitalization), its debt, and its cash. As noted above, market capitalization and debt increase the enterprise value, while cash and cash equivalents decrease the enterprise value. Enterprise value reflects the price that an acquirer would need to pay if they were to buy the company outright.
• Market Capitalization is simply the value of the company’s outstanding shares, and is sometimes referred to as the company’s “equity value”. It does not directly reflect the value of the company’s debt or cash and cash equivalents.

Using Enterprise Value in Financial Multiples

Enterprise Value multiples are valuable tools for comparing companies across industries or within the same sector. Common multiples include:

• EV / Sales: This ratio compares the enterprise value to the company’s total sales, essentially reflecting how the market values each dollar of sales. Note that “sales” and “revenue” are synonymous in this context.
• EV / EBITDA: This metric compares enterprise value to earnings before interest, taxes, depreciation, and amortization (EBITDA). It is a popular metric in the private equity industry and useful for understanding the company’s profitability and operating performance.

When using these multiples to compare companies within and across industries, be careful to ensure that the metrics are being calculated consistently. As we have seen above, sources will sometimes differ in their treatment of certain details, such as whether or not to include short-term investments as part of cash and cash equivalents in our Microsoft example.

Why is Cash Deducted from Enterprise Value?

Cash and Cash Equivalents are subtracted from enterprise value because a potential acquirer could use the cash to help finance the purchase of the company. Similarly, if the company had some debt, it could use the company’s cash and cash equivalents to help pay off its debts.

Key Takeaways

Enterprise value is an important concept for a variety of stakeholders in the financial markets.

• For investors, particularly those acquiring private companies, it can help determine how much money needs to be raised in order to finance an acquisition.
• For analysts, it can help facilitate comparisons of companies within industries.
• For corporate executives, it can help inform strategic planning, especially for mergers and acquisitions.

Overall, enterprise value is a useful concept because it reflects not just the value of a company’s equity, but also its financial structure, including its debt and cash. It is widely used in mergers and acquisitions, as well as in popular financial ratios such as EV / EBITDA. Although it has its limitations, such as its volatility to share prices, it remains a valuable tool in modern finance.

Additional Resources

If you found this article useful, consider checking out our Complete Finance & Valuation Course where we help students learn the technical skills needed to perform in competitive finance and investment roles. Use this course to join our students who have landed roles at Goldman Sachs, Amazon, Bloomberg, and other great companies!

Other Articles You Might Find Helpful

• EBIT Formula and Examples
• Liquidity Ratios
• Treasury Stock Method
• Contribution Margin Ratio
• Gross Profit