Imagine you want to buy a house. The asking price is £500,000, but the seller has a £200,000 mortgage on it and £10,000 in cash sitting in a joint account. As the buyer, you'd inherit the mortgage and get the cash — so the real cost of the house to you is £500,000 + £200,000 − £10,000 = £690,000. Enterprise value works the same way for companies.
The formula
Why EV matters in valuation
The most important reason EV matters: you use it with earnings metrics that belong to the whole firm, not just to shareholders. EBITDA, EBIT, and free cash flow all flow to both debt holders and equity holders. So the correct ratio is EV ÷ EBITDA, not market cap ÷ EBITDA.
Using market cap with EBITDA is a common analytical mistake. It can make heavily-indebted companies look cheap (low market cap) when they're actually expensive once you account for the debt they carry.
A practical example
| Company A | Company B | |
|---|---|---|
| Market cap | £500m | £500m |
| Debt | £400m | £0m |
| Cash | −£50m | −£100m |
| Enterprise Value | £850m | £400m |
| EBITDA | £100m | £100m |
| EV/EBITDA | 8.5× (expensive) | 4.0× (cheap) |
Same market cap. Same EBITDA. But Company A costs more than twice as much to acquire because of its debt load.
What this means for you
Whenever a company's valuation is quoted as a multiple, check whether they're using market cap or enterprise value as the numerator. EV-based multiples (EV/EBITDA, EV/EBIT, EV/FCF) are almost always more meaningful for comparing companies. Market cap-based multiples like P/E have their place, but only for equity-level metrics like earnings per share.