What is Enterprise Value and why is it important?

What is Enterprise Value and why is it important

The taking over of companies is a common practice in the corporate world. When one organization decides to take over another, its net worth is measured. In other words, the Enterprise Value is measured. By looking at the EV, one company can decide about buying another organization.

Apparently, EV is considered to be the same as Market Capitalization (MC). However, if you view the formula of EV, you would see that two other parameters are also incorporated to check the net worth of a company.

EV formula

The formula to determine EV is given as follows.

EV = MC + Total Debt – C

The terms used above have the following interpretations

  • EV = Enterprise Value
  • MC = Market Capitalization (In literal terms MC is the product of stock price and number of outstanding shares)
  • Total Debt (It is calculated by adding the short term and long term debts)
  • C is the Cash and related equivalents (This term defines the liquid assets of a company). However, there is no inclusion of marketable securities.

Elaboration through example

Let us consider that a company has the following values

MC = 10000

Total Debt = 5000

Cash and equivalents = 1500

Thus, EV is given as

EV = 10000 + 5000 – 1500

EV = 13500

EV prevents monetary losses

Purchasing a company is not a decision taken rapidly an organization. Several parameters highlighting the financial position of a company are considered. EV gives a clear insight of the financial condition of the company. On the basis of this value, an organization can decide whether it has to take over another company or not.

The essential role of an EV calculator

Would you add twenty numbers manually when you have a calculator in hand? The best way of calculating EV is using an online calculator. Four major benefits of using an Enterprise Value calculator are given below.

1. The risk of inaccurate interpretations is eliminated

Financial takeovers can prove to be nightmares if calculations are inaccurate. It is simply foolishness and application of an outdated approach to determine the EV of a company manually. Even financial experts do not adopt this approach because the risk of committing error is present.

  • The use of an EV calculator means that you can flush down the possibilities of making errors. If the value of EV is incorrect, the purchasing stakeholder would view the company status in the wrong manner. It may ignore a profitable deal or opt for one with losses. Using a quality EV calculator is a 100% assurance that the financial standing of the company has been calculated correctly.

2. Precious time is not wasted

With modern-day online calculators available, it is simply wastage of time to sit down with a pen and paper to determine EV. A quality EV calculator is the best way to find the accurate value in a very short while. In less than a minute, you would know about the accurate EV. On the other hand, if you plan to accomplish the task manually without using a calculator, you should be prepared to spend a longer time frame.

3. EV calculators are feasible for all types of users

Every user who wishes to determine the EV of a company may not have abundant financial knowledge. For instance, consider that a company does not have a dedicated financial team. The owner wishes to purchase another company and wants to check the financial standing. If he does not have core finance knowledge, it would be impossible for him to check the EV value.

  • There is no need to have conceptual logic about determining EV if you are using an online calculator. There is no need to learn formulae or see how they are used. No such requirements have to completed by the user. Simply enter the needed inputs and the online calculator would generate the EV value in quick time. From the user’s perspective, this is the best way to determine the EV value without any domain knowledge.

The process of using the EV tool (with example)

As it has been mentioned above, there is nothing complicated about using the EV calculator. We can gain more information by going through the input steps and outputs produced.

Knowing about the inputs to be entered

While using the EV calculation tool, enter the inputs given below in their respective text boxes. EV calculators have proper fields for each one of them. Consider the following input values.

  • Market Capitalization      = 1000
  • Minority Interest              = 250
  • Preferred Shares                = 250
  • Value of Debt                       =100
  • Cash and Cash equivalents = 75.

When you click the calculate button, the EV value would be instantly generated (1575 according to the above-mentioned inputs)

EV is calculated by several user types

Enterprise Value is a key factor for several types of users. Some of them are listed below.

Business owners

Purchasing a company is one of the most important decisions for any business owner. Entrepreneurs need to determine the EV so that they can determine the positives and negatives of the company being considered for take over. The EV is the price that needs to be paid to purchase the company. For every business owner, the EV factor is critical.

Corporate Financial Analysts

Corporate companies usually have a team of financial analysts to check the particulars of a company prior to take over. The EV is an exact measure of how financially sound a company is. If the company has a negative EV, it simply means that taking over the company would result in monetary losses. Financial analysts are responsible to determine the accurate EV so that a purchasing decision does not go wrong.

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