Most people in the business world are familiar with the term "market capitalization," or "market cap." It's a measure of how much a company is worth, and is calculated by multiplying the current stock price by the number of shares outstanding. For example, if a company has 1 million shares outstanding and the stock price is $10 per share, the market cap is $10 million.
However, there's another measure of a company's value that's often used by financial professionals, and that's enterprise value. So what's the difference between enterprise value and market capitalization?
Enterprise value is a measure of a company's total value, including both equity and debt. To calculate enterprise value, you start with the market cap, and then add or subtract other elements, as follows:
For example, let's say a company has $1 million in debt, $500,000 in preferred shares, and $200,000 in cash. The market cap is $10 million. The enterprise value would be calculated as follows:
$10 million (market cap) + $1 million (debt) + $500,000 (preferred shares) - $200,000 (cash) = $11.3 million
As you can see, enterprise value is a more comprehensive measure of a company's worth than market capitalization.
There are a few reasons why enterprise value is a useful metric. First, it's a more accurate measure of a company's true value. If you're trying to compare two companies, you want to use a metric that includes all forms of capitalization, not just equity.
Second, enterprise value is used in some valuation models, such as the discounted cash flow (DCF) model. This model is used to estimate the intrinsic value of a company, and it relies on inputs such as the company's cash flow, growth rate, and discount rate.
Finally, enterprise value is often used in merger and acquisition (M&A) analysis. When two companies are considering a merger, they need to know not only the market value of each company, but also the enterprise value. This will give them a more accurate picture of the true value of the combined company.
Market capitalization is a popular metric for measuring a company's value, but it's not the only metric. Enterprise value is another measure of a company's worth, and it's a more comprehensive metric that includes both equity and debt.