FREE online courses on Financial Management and Creating Value - Chapter 4 - Course Summary

 

Everyone from the Accounting Department to the Shareholder must see through the traditional accounting model. We need to break our addiction to earnings and recognize how to measure real performance. When we look at "value", we have a much more comprehensive way of measuring performance within an organization. The Finance and Accounting Department can play a lead role in making this transformation over to value-creation. The main objective is to increase values as opposed to earnings. In his book Quest for Value, G. Bennett Stewart III points out that "share prices are the result of discounting future expected cash flows, not earnings."

 

What a Manager does with cash determines value. The limited resources of the organization must be deployed in a manner that increases value. This requires that decisions be made based on generating returns from resources invested that are higher than the cost of capital. Value Based Management is the formal program for managing the organization around these principles. Value Based Management will include ways of measuring value, such as Economic Value Added, Cash Flow Return on Investment, and Residual Cash Flow. All three of these approaches to measuring value depart from the traditional accounting model. For example, there is a real cost associated with the use of capital and this should be recognized in the determination of residual income.

 

In order to create value, we can initiate financial restructurings where appropriate. According to the Wharton Business School, financial restructurings such as Leveraged Buy Outs and Recapitalizations have the biggest payoffs followed by asset restructurings like spin offs and sell offs. Organizational restructurings, such as downsizing, are not good sources of value-creation. Also, don't be afraid to use debt as part of a financial restructuring.

 

Finally, real sources of value go beyond financial restructurings. They include things like great customer service or extremely efficient production operations. When a company can reinvent itself, like the way IKEA sells furniture or the way ebay executes auctions, you will invariably find very high sources of value. The ability to engage in innovative strategizing and change how things are done is by far the greatest source of value-creation.