What is Enterprise Value to Cash Flow from Operations (EV/CFO)?
Enterprise value to cash flow from operations (EV/CFO) is the ratio of the entire economic value of a company to the cash it produces. The formula for EV/CFO is:
EV/CFO = (Market Capitalization + Total Debt – Cash)/Cash from Operations
Some analysts adjust the debt portion of the formula to include preferred stock; they may also adjust the cash portion of the formula to include current accounts receivable and liquid inventory.
How Does Enterprise Value to Cash Flow from Operations (EV/CFO) Work?
Let's assume Company XYZ’s balance sheet has the following characteristics:
Shares Outstanding: 1,000,000
Current Share Price: $5
Total Debt: $1,000,000
Total Cash: $500,000
On Company XYZ’s cash flow statement, we can see that the company recorded $300,000 of cash from operations last year.
Based on the formula above, we can calculate XYZ Company's EV/CFO as follows:
(($1,000,000 x $5) + $1,000,000 - $500,000)/$300,000 = 18.33
Why Does Enterprise Value to Cash Flow from Operations (EV/CFO) Matter?
When you divide EV by CFO, you're essentially calculating the number of years it would take to buy the entire business if you were able to use all the company's operating cash flow to buy all the outstanding stock and pay off all the outstanding debt. In other words, how long does it take the company to pay for itself?
When attempting to gauge the overall value Wall Street has assigned to a firm, investors often look exclusively at market capitalization (calculated by multiplying the number of outstanding shares by the current share price). However, in most cases this is not an accurate reflection of a company's true value. Enterprise value goes beyond the price of simply purchasing all of a company's stock.
Most significantly, enterprise value considers the fact that an acquirer must also shoulder the cost of assuming the acquired company's debt. Additionally, enterprise value considers the fact that the acquirer would also receive all of the acquired company's cash. This cash effectively reduces the cost of acquiring the company.
The effect of debt and cash is why two companies may have the same market capitalizations but very different enterprise values. For example, a company with a $50 million market capitalization, no debt, and $10 million of cash is cheaper to acquire than the same company with $10 million of debt and no cash.
