Why is cash subtracted from Enterprise Value during calculations?

The reasoning behind subtracting cash from Enterprise Value lies in its relationship with equity value. Enterprise Value represents the total value of a business from the perspective of all stakeholders, including debt and equity holders. It encompasses the company's market capitalization and its debt, minus its cash and cash equivalents.

When determining the purchase price or valuation for an acquisition, enterprise value gives a clearer picture of what it costs to buy the whole company. Since cash can be used to pay off liabilities, it effectively reduces the net cost to the buyer. Therefore, cash is already part of the equity value—if someone were to buy the equity of the company, they would also acquire its cash. Subtracting cash from enterprise value ensures that the transaction accounts for the cash position and reflects the net cost properly.

Cash is not subtracted because it can only be used to pay dividends or because reducing cash increases assets, as those considerations do not directly influence the calculation of enterprise value in the context of a purchase or acquisition. The aim is to arrive at a valuation that accurately reflects the financial obligations and net worth of the business, making it essential to recognize the liquidity that cash represents.