A simplified way to understand the EV concept is to envision purchasing an entire business. If you settle with all the security holders, you pay EV. Counter-intuitively, increases or decreases in enterprise value do not necessarily correspond to “value creation” or “value destruction”. Any acquisition of assets (whether paid for in cash or through share issues) will increase EV, whether or not those assets are productive. Similarly, reductions in capital intensity (for example by reducing working capital) will reduce EV.

Enterprise valuation is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. EV includes in its calculation the market capitalization of a company but also short-term and long-term debt as well as any cash on the company’s balance sheet. Enterprise value is a popular metric used to value a company for a potential takeover.

What Does Enterprise Value Tell You?

Enterprise value (EV) could be thought of like the theoretical takeover price if a company were to be bought. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm’s value. The value of a firm’s debt, for example, would need to be paid off by the buyer when taking over a company. As a result, enterprise value provides a much more accurate takeover valuation because it includes debt in its value calculation. Why doesn’t market capitalization properly represent a firm’s value? It leaves a lot of important factors out, such as a company’s debt on the one hand and its cash reserves on the other. Enterprise value is a modification of market cap, as it incorporates debt and cash for determining a company’s valuation.