enterprise value

Do you want to see what a business is really worth in the context of its debt and cash? Enterprise value can provide more depth than share price alone. It can help you weigh how two businesses stack up once you account for how they have raised money and how much cash they hold.

It can also help you spot possible risk when a company leans heavily on borrowing. In this article, Wealth Professional Canada will look at what enterprise value is, how to calculate it, and more!

What is enterprise value?

Most investors immediately look at market capitalization when they think about the size of a company, so that’s where we’ll start. Market cap is simple. You multiply the current share price by the total number of common shares that have been issued to investors. The result tells you how much the equity portion of the business is worth in the market.

Enterprise value goes a step further. It is designed to reflect the value of the entire business, not just the shares. To do this, it starts with market cap and then adjusts for two important items on the balance sheet. It adds total debt and subtracts cash and cash equivalents.

In simple terms, enterprise value answers this question: Suppose that someone bought the whole company. How much would that person effectively be paying once you consider the debt that comes with the purchase and the cash that comes with it as well?

This is why enterprise value is widely used when a business is being acquired. The buyer does not only purchase the shares. The buyer also takes on the target company’s borrowings, but at the same time gains access to its cash. Enterprise value tries to reflect that combined effect in one figure.

Watch this video to learn more about enterprise value:

Enterprise value is also useful in fundamental analysis. When paired with other financial ratios and metrics, it can help identify companies that might be attractive investment opportunities for your clients.

What does enterprise value tell investors?

Enterprise value helps you look at a business from a more complete perspective than share price and market cap alone. When you include both debt and cash in your valuation, 3 things become easier to see:

1: A better sense of company size

First, enterprise value gives you a stronger sense of how large a business really is. Two companies can have the same market cap, but very different levels of debt and cash. Enterprise value adjusts for those differences.

For example, a company that carries heavy debt and limited cash will have a higher enterprise value relative to its market cap. As for another company, suppose that it has little or no borrowings and a large cash balance. It can end up with an enterprise value that is much closer to, or even lower than, its market cap.

For financial advisors who compare stocks within the same industry, this can change how expensive or cheap a company looks once you move past equity alone. Some high-growth technology stocks might appear overpriced on market cap. When you factor in that they hold large cash balances and have little debt, the enterprise value can suggest a more reasonable valuation.

2: Insight into capital structure and risk

Enterprise value also draws attention to how a company has funded its operations. A business that relies heavily on borrowed money will generally show a higher enterprise value than one that has leaned more on equity and cash generation.

Comparing enterprise values among competitors in the same sector can help you identify:

• which companies are more dependent on debt
• which companies hold more cash as a buffer
• where indebtedness looks high relative to peers

If a company’s enterprise value is elevated because of heavy debt and limited cash, that structure can increase financial risk. This is especially true in industries where revenue can be cyclical or where large capital projects are hard to reduce once started.

3: Support for profitability analysis

Enterprise value can also help when you think about profitability. Instead of just looking at earnings relative to share price or basic earnings per share, you can think about earnings in relation to the value of the entire firm.

This means focusing on earnings compared with the value of the whole business, not just its shares. It includes what is owed and what is held in cash.

This perspective helps you judge how effectively a company generates earnings given the assets and liabilities on its balance sheet. The idea is that enterprise value encourages you to compare earnings to a figure that includes both equity and debt, not just the equity portion alone.

There’s also a concept called enterprise value lending. It means assessing the total value of a company and lending against that while taking security over the whole business instead of a specific asset. This is usually done at lower loan-to-value levels.

What is the enterprise value formula?

Here’s the formula for getting the enterprise value:

Let’s use a sample scenario. Suppose that your clients are interested in Company X, a mid-sized manufacturing company in Ontario. As their financial advisor, you can explain what this business is worth using enterprise value.

Company X’s share price is $25, and with eight million shares outstanding you first calculate a market capitalization of $200 million. Its total debt is $80 million, and Company X holds $10 million in cash and cash equivalents.

Using the formula, you get an enterprise value of $270 million, which reflects the value of the whole business, not just its equity. Check out this clip to learn more about calculating the enterprise value:

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Limitations of enterprise value

Here are 3 limitations of this financial metric:

1. Different stages in the business cycle

If you compare an early-stage growth company to a more established peer, enterprise value can be misleading. Younger firms often show higher growth potential but hold less debt because they have not yet built up large balance sheets or long histories of borrowing.

Older firms might have more debt as a result of decades of expansion and acquisitions. Since enterprise value adds debt, the mature company can appear more expensive even if the growth outlook is lower.

That does not always reflect investment quality in a direct way, especially if you are looking for growth for your clients.

2. Different industries with different capital needs

Comparing enterprise value across sectors also carries risk. A software firm might need only modest investment in property and equipment. It can run with low levels of debt and still grow. An energy company often needs large amounts of capital for physical assets, so it leans more heavily on borrowings.

If you set these two companies side by side based on enterprise value, the energy firm might look more indebted and therefore weaker. In reality, its higher debt can simply reflect the nature of its industry.

3. Early-stage companies in growth mode

When you look at companies that are still early in their growth journey, enterprise value is less useful. It is not as effective as a measure of how inexpensive or expensive they are relative to established peers. Their lower debt and stronger growth in revenue might not show up well through enterprise value alone.

In these cases, it can be better to rely on other metrics and to consider enterprise value as one part of a wider review. This is especially true if you are matching growth stocks to your clients’ long-term goals.

Enterprise value in the context of mergers and acquisitions

When a business is purchased outright, the buyer does not just buy the shares. The buyer is in effect taking over everything the company owns and everything it owes. That includes:

• all existing debt agreements
• all cash and short-term cash equivalents

Enterprise value reflects this full transfer. In a purchase, the buyer needs to consider:

• the cost of buying all the equity from existing shareholders
• the responsibility for repaying the target’s borrowings over time
• the benefit of adding the target’s cash balance to the combined entity

This perspective reinforces why enterprise value adds debt and subtracts cash. It tries to simulate what a buyer is really paying to gain control of the business, rather than focusing only on the stock price.

When you use enterprise value in your analysis, you are in a sense thinking like a buyer of the entire company, not just someone trading its shares.

Including enterprise value in financial planning conversations

Enterprise value is not a standalone answer. It works best when you compare similar businesses and becomes less helpful when you look across very different industries. The same is true when you match young growth companies to mature peers.

When you know these strengths and limits, enterprise value can deepen your conversations with your clients. You can explain why a stock that looks attractive on share price might carry more balance sheet risk than it first appears. You can also discuss why a company with a large cash reserve and low debt might offer added resilience.

To end, when you add enterprise value into your regular research, you provide your clients a more grounded understanding of what they own and why.

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