Both measures are useful in evaluating a company’s financial health, but they provide different perspectives regarding the company’s value. Understanding the difference between Market Cap and Enterprise Value will help you make educated procurement decisions that align with your investment goals.
Market Cap, also known as market capitalization is the total value of a company’s outstanding shares listed on the stock exchange. It doesn’t consider the company’s debt, therefore it can provide an inaccurate picture of the overall worth of a business. Enterprise Value is an alternative, but it adds the debt of a company to its equity and subtracts cash to provide an overall view of its value.
Adding a company’s debt gives you an idea of the firm’s financial obligations, which must be paid over enterprise value vs market cap time, and its ability to invest in growth opportunities and pay dividends to shareholders. Additionally, subtracting the company’s cash will give you an idea of its liquidity, which is the amount of cash it has available.
The EV to Market Cap ratio offers an easy way to evaluate companies for potential investments however it is not a way to replace due diligence or financial modeling. Additionally the EV to Market Cap ratio is not a good indicator of a company’s value relative against its peers, since it does not take into account the different characteristics of each firm’s capital structures and risk profiles.