Enterprise value and EV multiples – A step by step guide

Enterprise value is a powerful tool in equity valuation, both in discounted cash flow and related techniques such as residual income as well as valuation multiples. It produces more comparable metrics that are less impacted by differences in leverage and non-operating investments and better deals with dilutive instruments such as options.

However, EV is also easy to get wrong. Follow this guide to ensure that enterprise value is complete and consistent with the profit and cash flow metrics used in DCF and to produce EV multiples.

To read more about common mistakes in calculating EV see our article Enterprise value – calculation and mis-calculation.

Total enterprise value

Total enterprise value is the sum of all financing related claims on the business

Step 1: Calculate market capitalisation

  • Include all classes of ordinary shares
  • Do not include treasury shares or shares that are ‘authorised’ but not issued
  • Use basic not the diluted share count (unless the value of equity derivatives is omitted in step 2)
  • Include all classes of equity instruments

Step 2: Identify fair value of equity derivatives

  • If material, estimate the fair value of outstanding options and other equity derivatives such as written and purchased puts and calls on ordinary shares
  • Include the fair value of outstanding employee stock options but only to the extent that awards are expected to vest
  • An option model is usually required as fair values are generally not disclosed
  • If this step is omitted, then include dilution due to equity derivatives in step 1
  • Do not include convertible conversion options if the full fair value of convertibles is included in step 4

Step 3: Identify fair value of non-controlling interests (NCI)

  • If presented as a liability (NCI puts) use book value
  • If presented as component of equity, consider whether material enough to calculate a fair value otherwise use book value
  • For the fair value of NCI of listed subsidiaries used market price
  • For other NCI estimate FV by applying a valuation multiple such as P/BV or P/E

Step 4: Identify fair value of all (net) debt financing, including leases

  • Include all short-term and long-term debt, hybrid instruments classified as debt and preference shares
  • Include all capitalised lease liabilities
  • Check financial statements for any material difference between fair value and book value
  • Pay particular attention to convertibles as fair value is almost certainly higher than book value
  • Deduct cash and marketable securities to produce net debt (unless these are included separately as investments below)
  • Consider whether some cash balances should be regarded as operating
  • Consider whether there is a significant seasonal variation in net debt. If necessary, adjust balance sheet net debt to reflect seasonality

Step 5: Identify fair value of derivatives related to debt financing

  • Some derivatives such as interest rate swaps may relate to financing rather than operating activities
  • If material include the fair value of these derivatives as part of debt in enterprise value

Step 6: Identify defined benefit pension and healthcare liabilities

  • Use balance sheet value of any pension deficit or surplus
  • Adjust for taxation (usually you will find a separately disclosed deferred tax amount)
  • If any pension plans are ‘multi-employer’ check that defined benefit accounting is applied. If not consider the need for adjustments

Step 7: Identify other debt-like provisions

  • Include environmental, decommissioning and other similar liabilities
  • Use balance sheet value but check that assumptions are realistic
  • Adjust for taxation if future settlement of the liability is tax deductible – check deferred tax
  • Check whether there is a related sinking fund asset portfolio and make sure this is deducted here or included in investments below

Step 8: Consider whether other liabilities should be regarded as financing

  • Some liabilities normally thought of as operating may be better treated as financing
  • Examples are supply chain finance related liabilities and other extended trade credit
  • If trade payables are on normal credit terms leave as operating, if not consider including as financing if material

Step 9: Calculate total enterprise value

  • Total enterprise value = Sum of steps 1 to 8 above

Operating enterprise value

Operating (sometimes referred to as ‘core’) enterprise value is total EV less investments and other non-operating assets that are best dealt with separately in equity analysis.

Step 1: Identify the fair value of non-operating investments

  • Include investments such as holdings of bonds, equity shares and investment properties
  • Many but not all investments are reported at fair value. Check the notes for FV disclosures
  • Include investments in equity accounted associates and joint ventures
  • Estimate the fair value of these equity accounted investments

Step 2: Identify fair value of ‘discontinuing operations’

  • Only include discontinuing operations that are not sold on the date of the EV measurement
  • Estimate fair value by applying a valuation multiple if the sale price is not known

Step 3 Calculate operating enterprise value

  • Operating enterprise value equals total EV less steps 1 and 2 above

Enterprise value multiples

Enterprise value multiples are best calculated using the operating EV. This may be combined with any consistently calculated measure of profit, cash flow or assets

Step 1: Ensure that interest and financing costs are correctly classified

  • Interest that relates to debt and other debt-like liabilities that have been included in EV above should not be included in profit or cash flow metrics used for EV multiples
  • Interest related to operating liabilities (such as trade receivables) should be included in operating profit
  • For cash flow multiples ensure that cash flow includes all effective flows, such as leases and share-based compensation

Step 2: Ensure investment income and associate income is correctly classified

  • If investments are deducted in calculating operating EV then do not include related income in operating profit or other metrics used in EV multiples

Step 3: Calculate EV multiples

  • Compare operating EV with your chosen measure of performance or cash flow