While market cap is an effective measurement, it has some limitations in determining the true size and value of a business. In contrast, enterprise value is a more holistic measure of the worth of a firm that considers all aspects of a business’s capital structure including debt and cash.
The formula used to calculate the Enterprise Value of a company is simple it is: Current shareholder price (market capitalization) plus the total amount of short- and long-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 a key driver for valuation multiples like EV/EBITDA and EV/Sales.
Businesses and investors who are seeking to acquire a new business rely on the value of the as it offers an extensive theoretical analysis of its market value. It also has some significant distinctions from market cap, such as the fact that it isn’t dependent on fluctuations in trading trends.
Additionally, although market cap is usually used to classify companies into categories like small-cap, medium-cap and large-cap, EV isn’t. However, both can provide valuable insights for entrepreneurs and investors in assessing the potential of a company to expand its market share. In the end, enterprise value can aid in identifying risks for investors like debt in relation to cash available. It can also help determine the company’s capacity to generate profits in relation to the capital in the bank. This is especially relevant when a company has a large amount of debt compared with equity.