EV to EBITDA, also known as "enterprise multiple" or "EBITDA multiple" is a financial ratio that allows investors to measure a company's earnings value. According to NASDAQ, the ratio often is used by larger companies when deciding whether or not to acquire a certain business. The ratio mixes financial accounting indicators with external market valuations.
Step 1: Calculate EV
Enterprise value -- EV, for short -- is a type of business valuation that determines a company's potential selling price. The metric is similar to market capitalization but also considers the debt and cash that a company holds. To calculate EV, follow these steps:
- Calculate market capitalization. To calculate this figure, multiply the number of shares a company has outstanding by the current market price per share.
- Add the company's total debt. Include both short-term debt and long-term debt. These numbers should be clearly labeled in the liabilities section of the balance sheet.
- Subtract cash and cash equivalents. This includes cash on hand, checking, savings and liquid investments that mature within three months.
For example, say that a company has 5,000 shares outstanding, valued at $10 per share. It also has $20,000 worth of debt and $10,000 worth of cash and cash equivalents. Market capitalization is 5,000 multiplied by $10, or $50,000. EV is $50,000 plus $20,000 less $10,000, or $60,000.
Step 2: Calculate EBITDA
EBITDA stands for "earnings before interest, taxes, depreciation and amortization." The easiest way to calculate EBITDA is to start with net income and add back the amounts listed for interest, tax, depreciation and amortization on the income statement. For example, if net income is $30,000 and the sum of interest, tax, depreciation and amortization expense is $20,000, then EBITDA is $50,000.
Step 3: Calculate EV to EBITDA
To calculate EV to EBITDA, divide the amount calculated for EV by the company's EBITDA. For example, if EV is $60,000 and EBITDA is $50,000, then EBITDA is 1.2. A lower ratio is better than a higher one. The lower the ratio, the more earnings power the buyer gets relative to the purchase price of the company.