What it means
Enterprise value, or EV, is the price tag for the whole business, not just the shares. It is built from the market value of the company's shares, plus its debt, minus the cash it holds.
The result shows what an acquirer would effectively have to pay to take over the entire operation. Dividing that figure by annual sales gives the EV/Sales multiple.
A multiple of 2.0 means the market values the business at two times its yearly revenue. Because the numerator includes debt as well as equity, the ratio is fair to compare across companies that fund themselves differently.
Analysts like this ratio when earnings are negative, unstable or distorted by one-off items. Young technology companies, for example, may be spending heavily on growth and reporting losses, so a price-to-earnings ratio is meaningless while sales still give a reference point.
Sales are also harder to manipulate than profit figures, which makes the measure more consistent. The ratio has clear limits, because revenue says nothing about how much of each sale turns into profit.
A grocery chain with thin margins and a software firm with high margins can have the same sales but very different worth. For this reason, EV/Sales is best compared between businesses in the same industry with similar margins and growth.
Finance teams use the multiple in several ways. They apply the typical multiple of comparable companies to their own sales to estimate a rough value, or they check whether a takeover offer looks reasonable.
Typical multiples vary widely by industry and market mood, so any benchmark should be taken from recent comparable data and not from memory. In everyday conversation the term is sometimes written as one phrase without the slash, and it should not be confused with price-to-sales, which uses market capitalisation (share price times number of shares) instead of enterprise value.
The two measures give similar results only when the company has little debt and little cash.
In practice
Real-world examples.
Example
A venture investor is comparing two software companies that are not yet profitable. One trades at an EV/Sales of 6.0 and the other at 3.5, with similar growth rates. She asks why the first deserves a higher multiple and finds it has better margins.
Example
A private equity firm reviews a food distributor with sales of $80,000,000. Similar listed businesses trade at around 0.5 times sales, so the firm estimates a value near $40,000,000. It then tests that estimate against profit-based methods before making an offer.
Example
A retail chain's finance director checks the company's own multiple after a share price drop. Debt has not changed, but the lower share price has pushed EV/Sales from 1.2 to 0.9. She prepares a note for the board explaining that the market is now pricing the business more cautiously.
Formula
Calculation
Enterprise value = Market capitalisation + Total debt - Cash and cash equivalents
EV/Sales = Enterprise value / Annual sales
Suppose a company has a market capitalisation of $400,000,000, total debt of $150,000,000 and cash of $50,000,000. Enterprise value = 400,000,000 + 150,000,000 - 50,000,000 = $500,000,000. If annual sales are $250,000,000, then EV/Sales = 500,000,000 / 250,000,000 = 2.0. The market is therefore valuing the whole business at two dollars for every dollar of yearly revenue.Case study
Seen in the real world.
Lumina Cloud is a fictional software company, and this story is illustrative. It had $30,000,000 in annual sales, was still making a small loss, and wanted to raise money from outside investors. The founders asked the finance lead to estimate a sensible valuation before the meetings began.
She collected the EV/Sales multiples of five listed companies of similar size and growth, which ranged from 4 to 7. After adjusting for Lumina's slightly lower margins, she chose a working range of 4 to 5 times sales, implying a value of $120,000,000 to $150,000,000. The founders used the range as an opening position and accepted that investors might push lower if growth slowed.
Watch out
Common mistakes.
- Using market capitalisation instead of enterprise value, which ignores the company's debt and cash.
- Comparing companies from different industries, when margins and growth rates differ widely.
- Treating a low EV/Sales as automatically cheap, when the business may have weak margins or falling sales.
Questions
People also ask.
Why use sales instead of profit?
Sales are positive for almost every company and are less affected by accounting choices, so they offer a steady base for comparison when profit is small or negative.
Is a higher EV/Sales always worse?
Not always, because a higher multiple can reflect faster growth or better margins, but it does mean investors expect more from the future.
What is a good EV/Sales ratio?
There is no universal answer because it depends on the industry, growth and profitability, so compare with similar companies at the same time.
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