Although market cap is a valuable metric, it has heavy limitations in terms of identifying the true value and size of a company. Enterprise value is a holistic measure of the worth of a company that takes into account all aspects of its capital structure including debt and cash.
The formula for calculating the value of a company’s enterprise is easy it is: Current shareholder price (market capitalization) plus the total of short and long-term loans plus preferred stock and minorities as well as cash and cash-equivalents. Enterprise value is used for comparing companies operating in the same field. It is also an important factor in determining valuation multipliers such as EV/EBITDA or EV/Sales.
Large corporations and investors looking to acquire a new company depend on EV because it provides a detailed theoretic calculation of the value of a company’s assets in the market. It’s also distinct from market capitalization in the sense that it does not rely on the fluctuation of trading trends.
In addition, while market cap is usually used for categorizing companies into categories such as small-cap, medium-cap and large-cap however EV is not. Both can provide valuable information for investors and entrepreneurs in assessing the potential of a business to expand in the market. In the end, enterprise value can help investors identify potential risks like indebtedness to cash on hand. It also can reveal a company’s capacity to generate profits relative to its capital. This is especially relevant for companies with large amounts of debt compared with equity.
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