Enterprise Value Vs Market Cap
Market cap is a useful measure however, it has a number of limitations when it comes to determining the worth and size of a company. Enterprise value is a comprehensive measure of the worth of a company that takes into account all aspects of its capital structure including cash and debt.
The formula to calculate a company’s enterprise value is simple: current price of the shareholder (market cap) plus the total of long- and short-term debt plus the total of all preferred shares and minority interests plus cash and cash equivalents. Enterprise value is often used to compare companies in the same sector and is the primary driver behind valuation multiples like EV/EBITDA and EV/Sales.
Large corporations and investors who are seeking to purchase a new business depend on the EV, as it provides an in-depth theoretical calculation of its market value. It’s also distinct from market capitalization in the sense that it doesn’t rely on the fluctuations in trading trends.
Additionally, although market cap is commonly used to classify companies into categories such as small-cap, mid-cap, and large-cap but EV isn’t. However, both can be valuable for entrepreneurs and investors to evaluate the company’s potential to expand its reach in the marketplace. Ultimately, enterprise value can help investors identify potential risks like indebtedness to cash on hand. It can also reveal the company’s ability to generate profits in relation to its capital. This is especially relevant for companies with large amounts of debt compared with equity.
