Enterprise value and equity value are two common ways that a business may be evaluated from a sales standpoint. Both may be used in the valuation or sale of a business, but each offers a slightly different view. While enterprise value gives an accurate calculation of the overall current value of a business, similar to a balance sheet, the equity value offers a snapshot of both current and potential future value.
How Enterprise Value Works
Enterprise value constitutes more than just outstanding equity. It theoretically reveals how much a business is worth, which is useful in comparing firms with different capital structures since capital structure doesn't affect the value of a firm. In the purchase of a company, an acquirer would have to assume the acquired company’s debt... along with the company’s cash. Acquiring the debt increases the cost to buy the company, but acquiring the cash reduces the cost of acquiring the company.
Businesses calculate enterprise value by adding up the market capitalization, or market cap, plus all of the debts in the company. Debts may include interest due to shareholders, preferred shares, and other such things that the company owes. Subtract any cash or cash equivalents that the business currently holds, and you get the enterprise value. Think of enterprise value as a business' balance sheet, accounting for all of its current stocks, debt, and cash.
The Difference Between Enterprise Value and Equity Value
How Equity Value Works
Equity value constitutes the value of the company's shares and loans that the shareholders have made available to the business. The calculation for equity value adds enterprise value to redundant assets and then subtracts debt net of cash available. Total equity value can then be further broken down into the value of shareholders' loans and (both common and preferred) shares outstanding.
Equity value and market capitalization are often considered similar and even used interchangeably, but there is a key difference: market capitalization only considers the value of the company's common shares. Preferred shares and shareholders' loans, meanwhile, are considered debt. By contrast, equity value includes these instruments in its calculation.
Equity value uses the same calculation as enterprise value but adds in the value of stock options, convertible securities, and other potential assets or liabilities for the company. Because it considers factors that may not currently impact the company, but can at any time, equity value offers an indication of potential future value and growth potential. The equity value may fluctuate on any given day due to the normal rise and fall of the stock market.
In most cases, a stock market investor, or someone who is interested in buying a controlling interest in a company, will rely on enterprise value for a fast and easy way to estimate the value. Equity value, on the other hand, is commonly used by owners and current shareholders to help shape future decisions.