Enterprise Value

Enterprise value is the total value of a business’s operating assets to everyone who funded them, lenders and owners together. It is assembled from the market value of the equity, plus total debt, preferred stock and noncontrolling interests, less cash and cash equivalents. It is an analytical construct rather than a reported amount: no balance sheet caption carries it, and the rules that use the term do not fix its components, so two analysts can build it differently from the same statements.

The Build-Up, Term by Term

The calculation starts from what the ownership stake is worth and adds every other claim on the same operating business.

enterprise value  =  equity market value
                  +  total debt
                  +  preferred stock
                  +  noncontrolling interests
                  -  cash and cash equivalents

Equity market value is the number of shares outstanding times the price per share. For a listed company that price is quoted every trading day, which is why this leg is usually called market capitalization.

Total debt is the interest-bearing borrowing a buyer would have to repay or assume. It is not one line on a filed balance sheet, because the noncurrent borrowings and the slice falling due inside the year sit under separate captions, a split long-term liabilities sets out.

Preferred stock is a class whose preference on dividends and on liquidation is drafted into the corporation’s own documents rather than assumed, the ground common stock covers. What the build-up cares about is where it sits. Regulation S-X gives it two captions, one for stock that must be redeemed or whose redemption is outside the issuer’s control and one for stock that is not redeemable or is redeemable solely at the issuer’s option, and securities reported under the first are not to be included under a general heading of stockholders’ equity (17 CFR 210.5-02). A claim the balance sheet deliberately holds outside equity is exactly the kind the build-up has to add back.

Noncontrolling interests are the parts of consolidated subsidiaries’ equity the parent does not own. Regulation S-X gives them a caption of their own, caption 31, set under its own heading after the stockholders’ equity captions and ahead of the closing caption 32, total liabilities and equity (17 CFR 210.5-02). The build-up adds them because the equity leg prices only the parent’s stake while the assets being valued are the whole consolidated operating business. Which equity subtotal a ratio should divide by is a separate question, one the equity multiplier works through.

Cash and cash equivalents are the one leg that is subtracted. The balance sheet caption is cash and cash items, and the equivalents idea comes from the cash flow standard: short-term, highly liquid investments that are both readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value from changes in interest rates, with generally only original maturities of three months or less qualifying (FASB Statement No. 95, paragraph 8). That Statement has since been superseded. It was one of the then-existing non-SEC accounting and reporting standards superseded on the effective date of Statement No. 168, which kept only a short list of named Statements authoritative until each was integrated into the Codification (FASB Statement of Financial Accounting Standards No. 168, paragraph 15).

A Worked Example

Say a company’s shares, borrowings and balances stand at the amounts below on one date.

Shares outstanding                          4,000,000
Price per share                                   $25
Equity market value  (4,000,000 x $25)   $100,000,000

Plus  total debt                          $30,000,000
Plus  preferred stock                      $5,000,000
Plus  noncontrolling interests             $2,000,000
Less  cash and cash equivalents           $12,000,000

Enterprise value                         $125,000,000

The equity leg and the answer are different numbers, and the gap between them is the funding rather than the business. Running the build-up backwards recovers the equity: take the debt, the preferred stock and the noncontrolling interests out of enterprise value, then put the cash back.

Why Cash Comes Out

A buyer who takes control of the whole business takes control of the cash sitting inside it, so the net outlay is what was paid for the equity and the borrowings, less the cash that arrives with them. That subtraction is what turns a price for the claims on a company into a price for the operating business those claims fund.

Where the cash balance is larger than the equity, debt, preferred and noncontrolling claims put together, the subtraction carries enterprise value below zero. That is arithmetic rather than a verdict on the business.

Why One Balance Sheet Supports Two Answers

Start with what the accounting rules do not do. Enterprise value is not among the line items Regulation S-X lists for the face of a balance sheet (17 CFR 210.5-02), so nothing in a filed statement settles the components for you.

The tax rules borrow the term rather than define it. The transfer pricing regulations apply the market capitalization method based on the enterprise value of the company in a worked example, without stating what that amount contains (Treasury Regulation section 1.482-8, Example 15).

The subtracted leg is looser still. Not every qualifying investment has to be treated as a cash equivalent, because an entity sets its own policy on which short-term, highly liquid investments meeting the definition are counted that way (FASB Statement No. 95, paragraph 10). That latitude belongs to the reporting entity rather than to the reader, and the entity has to disclose the policy it settled on, so the same qualifying investment can sit inside cash at one company and outside it at another. What lets two people build enterprise value differently from one set of statements is that no rule fixes the components at all, so the components belong next to the figure whenever it is quoted. Free cash flow needs the same discipline for the same reason.

What Enterprise Value Is Not

Equity value is what the ownership stake alone is worth, once lenders and preferred holders have been satisfied, while enterprise value covers those claims too. On a listed company the equity value is the market capitalization, which is why a share price on its own says nothing about how much borrowing stands behind it.

Book equity is not equity value either. It is a balance sheet residual, total assets less total liabilities, at the carrying amounts the accounting rules produce rather than at market, set out in owner’s equity and in net assets. Equity value asks what the stake would fetch, and carrying amounts are not built to answer that.

Enterprise Value of a Privately Held Firm

A privately held CPA practice has no quoted share price, so the build-up has no market capitalization to start from. The equity leg has to come from an appraised or a transacted value instead, reached under a stated standard of value and as of a stated date, which is the ground valuation covers.

Where a practice carries no interest-bearing borrowing, no preferred interests and no part-owned subsidiary, the build-up collapses to its equity value less its cash. What a buyer of a practice is actually pricing is worked through in how to value a CPA firm and in private equity in accounting firms.

Common Questions

Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can put a real block of its own recurring compliance work through a trial task to free its partners for the analysis clients actually ask for.