In calculating an operating enterprise value, only the operating returns and capital would be used.The value for non-equity finance would be calculated using the financing returns and capital and the value of the non-core assets would be derived from the non-core returns and capital. What is crucially important is that the correct returns and capital items are used in each part of a valuation, e.g. returns from non-core assets should not be used to calculate the value of operating assets, etc.
When producing a valuation therefore, the elements of a company’s returns and capital must be broken down into three key areas:
A calculation of enterprise and equity values will start by analysing the operating and financial items in a set of accounts. Operating items relate to enterprise value, the value of the entirety of the operations of the business, while financing items are deducted from enterprise value to get to equity value. Non-core items are extracted from the accounts and valued separately. As discussed, an example of non-core items would be Nestlé’s investment in L’Oréal, which is a non-core investment (food vs. cosmetics).
Non-core Assets and Liabilities
Key learning points:
- Returns and capital can be broken down into operating, financing and noncore items.
- Operating items relate to enterprise value and include returns such as EBITDA and capital.
- Financing items relate to non-equity finance and if deducted from operating items, produce equity returns or capital.
- Non-core items do not relate to the core activities of the business and should be extracted.