How It Works/Example:
Market Capitalization + Total Debt - Cash = Enterprise Value
Some analysts adjust the debt portion of this formula to include preferred stock; they may also adjust the cash portion of the formula to include various cash equivalents such as current accounts receivableand liquid inventory.
Shares Outstanding: 1,000,000
Current Share Price: $5
Total Debt: $1,000,000
Total Cash: $500,000
Based on the formula above, we can calculate Company XYZ's enterprise value as follows:
Why It Matters:
Debt and cash can have an enormous impact on a particular company's enterprise value. For this reason, two companies with the same market capitalizations may sport very different enterprise values. For example, a company with a $50 million market capitalization, no debt, and $10 million in cash would be cheaper to acquire than the same $50 million company with $30 million of debt and no cash.
The P/E ratio and other formulas commonly used to measure value don't typically take cash and debt into consideration. For this reason, it's sometimes called the "flawed P/E ratio." To get a better sense for a company's true valuation, many analysts and investors prefer to compare earnings, sales, and other measures to enterprise value.