Enterprise value, often shortened to EV, is a way of estimating what an entire business is worth, not just its shares. It starts with the value of the company’s equity, adds the debt it owes and subtracts the cash it holds. Analysts like it because it puts companies with very different amounts of borrowing on a more even footing.
The basic formula
In its simplest form, enterprise value looks like this:
- Start with market capitalisation, the share price multiplied by the number of shares.
- Add total debt, such as bank loans and bonds.
- Subtract cash and cash equivalents.
More detailed versions also add items such as preference shares and minority interests, and some include lease obligations. The core idea stays the same. If you want a refresher on the first step, our guide to market capitalisation covers how it is calculated.
Why debt is added and cash subtracted
A useful way to think about enterprise value is to imagine buying the whole company. You would pay the shareholders for their shares, but you would also take on the company’s debts, which someone would eventually have to repay. That makes the business more expensive than the share price alone suggests.
Cash works the other way. If the company has money sitting in the bank, that cash would effectively come to you as the new owner, reducing the real cost of the purchase. That is why it is subtracted.
A simple illustration
Imagine two companies, each with a market capitalisation of £500 million. These numbers are purely illustrative.
- Company A has no debt and £50 million of cash. Its enterprise value is £450 million.
- Company B has £300 million of debt and £20 million of cash. Its enterprise value is £780 million.
On a market value basis they look the same size. On an enterprise value basis, Company B is a much bigger financial commitment, because a buyer would also be taking on its borrowing.
Pairing EV with earnings
Enterprise value is most often used in ratios. The best known is EV to EBITDA, which compares the value of the whole business with its earnings before interest, tax, depreciation and amortisation. Our explainer on EBITDA covers what that earnings measure includes and leaves out.
The logic is consistent. EBITDA is earned before any interest is paid to lenders, so it belongs to both shareholders and lenders. Enterprise value also covers both groups. Matching them avoids comparing apples with pears, which is a problem with simpler ratios when debt levels differ widely.
Analysts also use EV to sales and EV to operating profit, depending on the industry and what they want to highlight.
Where enterprise value is useful
EV is popular in a few situations:
- Comparing companies in the same sector that carry very different levels of debt.
- Looking at potential takeover targets, where a buyer cares about the total cost.
- Valuing businesses with heavy investment needs, such as telecoms or utilities, where borrowing is a normal part of operations.
Where it can trip you up
Enterprise value is only as good as the numbers behind it. Debt figures in company accounts can be dated, and some obligations, such as pension deficits, may or may not be included depending on who does the calculation. Cash may be trapped overseas or needed to run the business day to day, so treating all of it as spare can flatter the result.
Different websites can show different enterprise values for the same company because they make different choices. When comparing companies, it helps to use one consistent source.
A low EV to EBITDA ratio can also be a warning, not a bargain. The market may be pricing in falling profits, rising costs or concerns about debt repayments.
Bringing it together
Enterprise value estimates the cost of buying a whole business by adding debt to market value and subtracting cash. It is most useful for comparing companies with different amounts of borrowing, especially when paired with earnings measures such as EBITDA. Like any valuation tool, it works best as one part of a wider look at the business.
If you want to check how well you understand company valuation, our free trader assessment is a good next step.
