Enterprise value: Definition, calculation and example

Enterprise value: Definition, calculation and examplesCompany value is one of the most used metrics in financial valuation in general and in the value investing in particular. In this article we will see the definition of company value, its calculation with an example and solutions to possible problems and finally we will analyze the specific case of negative company value.

Definition of company value

The enterprise value (“Enterprise value” in English, although it is common to refer to it by its acronym “EV”) is the difference between the capitalization bursátil of a company and its net financial debt.

Being a fairly complete metric, it is often used frequently when valuing companies, especially by companies of prívate equity. The most common way to use the enterprise value is to compare it with the EBITDA ("Earnings before interest, taxes, depreciation and amortization") resulting in the EV / EBITDA ratio.

Calculation of company value

The company value is calculated based on the market capitalization, to which we must add and subtract the following values. The formula is as follows:

Company value = Market capitalization + Market value of its debts - Cash and equivalents

The formula can be complicated in some cases, such as in the case that the company has off-balance-sheet debts, although it is not common, so for practical purposes this simplified formula is useful for the vast majority of cases.

Examples of enterprise value calculation

A company has a market capitalization of 300 million euros. This company also has debts worth 150 million euros and cash in the amount of 50 million. The calculation of the enterprise value is simple:

Company value = 300 million + 150 million - 50 million = 400 million euros

Possible problems in calculating enterprise value

The main problem for calculating company value comes from the fact that it is not possible to know the market value of a company's debts, since they are private debts that are not found in listed markets. In these cases, the most common is to use the book value of the debt as a good approximation to its real value.

Another problem may be that there are debts not reflected in the balance. In this case, we must analyze the memory, where these types of debts that the company must face in the future must be reflected.

Can there be a negative company value?

Although it is usually very rare, it can be the case of companies with negative company value. This can occur in companies with cash on hand that exceeds the sum of their net debt and market capitalization.

Companies with negative company value tend to appear at times of maximum market depression and can be great buying opportunities if they are the product of market irrationality.