While both are essential to assess the financial health of a business, they differ in their perception of the value of a company’s overall. Understanding the distinction between Market Cap and Enterprise Value will help you make educated procurement decisions that align with your investment goals.
Market capitalization is a measure of the value that a company can get from its outstanding shares listed on the stock market. It does not include a company’s outstanding debt, which could create a false perception of the value of the company. Enterprise Value however is a method of adding the company’s debt to equity, and subtracts it from its cash balance to provide a more complete picture of a company’s value.
The calculation of a company’s debt gives you an idea about the financial obligations that it has to meet over time. It will also give you an idea of its capacity to invest and pay dividends. By subtracting the money of a company, it gives you a sense of its liquidity or the amount of cash that it has available.
The EV/Market Cap ratio can be an efficient and quick method to determine the potential investment. However it’s not an alternative to due-diligence or financial modeling. Additionally, the EV to Market Cap ratio is not a reliable measure of a company’s worth to its competitors, since it fails to take into account the differences in each firm’s individual capital structures and risk profiles.