Hello friends. In this blog, we discuss various financial topics. That is why we have launched the ‘Stock Market Terms‘ series. This is the second post of that series. The topic of our discussion in today’s post is Enterprise Value. In the previous post, we discussed “Market Capitalization“. Click here to read that article because if you have a clear idea about market capitalization, it will be easy for you to understand Enterprise Value.
What is Enterprise Value?
Enterprise value is the actual value of a company, that is, the net amount a buyer has to pay to buy the company entirely. Market capitalization tells us about how much money one has to pay to buy a company wholly. In that case, the debt company has to repay, or the cash in hand to the company is not calculated. However, these two things are taken into account when determining the enterprise value of a company. That is why for a company, the enterprise value is more important than market capitalization as the enterprise value reveals the real value of the company.
How the Enterprise value of a company is determined?
The formula for determining the enterprise value of a company is as follows: –
Enterprise Value of Company = Market Capitalization of Company + Debt on Company – Current Cash in hand to Company
In this case, when determining the enterprise value, the debt of the company is added to the market capitalization of the company because after purchasing the company the buyer has to repay all the debt on that company. Again, since the current cash held by the company will be received by the buyer after the purchase of the company, the current cash is being deducted from the company while determining the enterprise value.
An example of determining the Enterprise Value
With the help of an example, we will understand how to determine the enterprise value of a company. Suppose you want to buy Reliance Industries company entirely. Now as of 08.02.22 (all figures in crores) –
Market capitalization of Reliance Industries = ₹ 15,77,356
Total debt on Reliance Industries = ₹ 2,21,698
Current cash with Reliance Industries = ₹ 5,573
Therefore, the current enterprise value of Reliance Industries = (15,77,356 + 2,21,698 – 5,573) = ₹ 17,93,481
Enterprise value can also be negative
The enterprise value of some companies can be negative many times. In that case, in the net, the buyer does not have to pay any money to buy the company but instead, he receives some money. Let us understand this with an example. Suppose a company’s,
Market capitalization = ₹ 100,000,000
Total debt on = ₹ 0
Near current cash = ₹ 1,30,000,000
Therefore the current enterprise value of the company = (₹ 100,000,000 + ₹ 0 -, 1,30,000,000) = – ₹ 30,000,000
This means that in the net, the buyer will not have to pay any money to buy the company, but instead, he will receive ₹ 30,000,000 after buying the company.
The importance of Enterprise Value
The enterprise value of a company is an important valuation factor. It can be very risky to invest in a company just by checking the market capitalization because the market capitalization does not include the debt on the company, so the real value of the company is not determined. Enterprise value, on the other hand, reflects the true value of the company, including not only the debt owed by the company but also the cash held by the company.
Hopefully, I’ve been able to give you a clear idea of what a company’s enterprise value means. Follow us to know all such information about various financial topics and to understand everything in simple language. If you have any questions about this post, please let us know in the comments or mail us at [email protected]. Share this article with others if you found it worthy. In this blog, we publish various articles on finance. To get all the post notifications from this blog, click on the red bell icon on the right side and turn on the notification. Thank you for spending your precious time reading this article. Stay well, stay healthy.