1) Operating income approach
Operating income is a measure of a company's profitability. It is calculated as expenses minus revenues, including operating and non-operating costs. The operating income approach is a way of calculating the difference between enterprise value and equity value.
The approach calculates the present value of expected future operating profits. This future operating profit is then discounted based on the company's weighted average cost of capital. The difference between enterprise value and equity value is the present value of excess cash flow or cash flow that is not needed to support business operations.
2) Cash flow to equity approach
Another way to calculate the difference between enterprise value and equity value is to use the cash flow to equity approach. This is a standard method you will come across when comparing enterprise value vs equity value . This approach takes into account a company's operating cash flow, depreciation, capital expenditures and interest payments. It then subtracts the company's dividends paid to shareholders. The result is a number that represents the amount of free cash flow to shareholders after all other obligations have been paid.
3) Residual income approach
The residual income approach is a way of calculating the difference between enterprise value and equity value. It is used to measure free cash flow to shareholders after all expenses and debts have been paid. Companies use this approach to assess the attractiveness or value of an investment for a business.
4) Book value approach
The book value approach is a method of calculating the difference between enterprise value and equity value. This approach takes into account the historical cost of assets and liabilities and any adjustments to these values over time. The book value approach is generally used by financial analysts when valuing companies.
The main advantage of the book value approach is that it is relatively simple to calculate. Experts can use this approach to assess companies of all sizes and in all industries. In addition, the book value approach is often used as a starting point for more complex valuation methods.
5) Approach to comparable companies
The comparable company approach is a valuation method that looks at publicly traded companies in the same industry with similar business characteristics to estimate a company's value. This approach is also sometimes called multi-comparable analysis or peer group analysis. The method is calculated by taking the average of the market capitalization of the companies in the peer group. It provides a more accurate estimate of a company's value than other valuation methods, such as the discounted cash flow method.
6) Discounted cash flow approach
Valuation of discounted cash flows (DCF) is a business that values by discounting future cash flows at present value. The idea behind this approach is that the value of the firm is equal to the sum of all its future cash flows, discounted at an appropriate rate.
The DCF approach has two main advantages over other valuation methods. First, it explicitly considers the time value of money, which is a crucial consideration in any investment decision. Second, it forces the analyst to think carefully about all the factors affecting a company's future cash flows and make explicit assumptions about those factors.
The DCF valuation is based on several assumptions about the future, which may or may not be correct. As a result, DCF valuation is more art than science, and different analysts can often arrive at very different values for the same company using this method.
Conclusion
The six methods above are all ways to calculate the difference between enterprise values and equity. Each method has its strengths and weaknesses. The best method to use depends on the situation.