Although market cap is a useful measure, it has significant limitations in terms of identifying the true size and value of a company. Enterprise value is a holistic measurement of a company’s worth that includes all aspects of its capital structure including cash and debt.
The formula for calculating the enterprise value of a business is as simple as it is: Current shareholder price (market capitalization) plus total long and short-term loans plus minorities and preferred stock, together with cash and cash-equivalents. Enterprise value is often used when comparing companies within the same industry and is the primary driver behind valuation multiples such as EV/EBITDA and even EV/Sales.
Businesses and investors who are looking to acquire a new company rely on the EV for a detailed theoretical calculation of its market value. It also has a few key differentiators from market cap for instance, it isn’t subject to changes in trading trends.
In addition, though market cap is commonly used to classify companies into categories like small-cap, mid-cap, and large-cap however EV is not. Both can provide valuable information to entrepreneurs and investors in assessing the company’s potential to grow in the market. Enterprise value can ultimately help investors recognize risks, such as debt versus cash available. It will also reveal a company’s ability http://www.dataroomtalk.info/how-to-evaluate-virtual-data-room-companies-services/ to generate income in relation to capital in the bank. This is particularly relevant for companies that have a significant amount of debt compared to equity.