By: Prof. Soman Nambiar
Sr. Professor, School of Management, Presidency University
Every single stake holder would have realised that Traditional Accounting Modeldoes not meet the true needs of firm-value optimization. One needs to break ‘one’s addiction to earnings and find other means to measure real performance. “Value” is one such comprehensive way of measuring performance within an organization. The Finance and Accounting Department can play a lead role in making this transformation from being earnings-centric towards value-creation.The main objective Financial Management is to increase values as opposed to earnings. In his Course Article “Creating Value through Financial Management “, Prof. Matt H Evans had quoted G. Bennett Stewart III from his book “Questfor Value”, that “share prices are the result of discounting future expected cash flows, not earnings.”
Value is determined by the manner in which a Manager uses his funds. The limited resources of the organization must be deployed in a manner that increases value. Value-enhancing decisions should be aimed at generating returns from resources invested that are higher than the appropriate cost of capital.Value-Based Management is the envisaged program for managing the organization around these principles. Value Based Management will include ways of measuring value, such as Economic Value Added [EVA], Cash Flow Return on Investment [CFROI] , and Residual Cash Flow [RCF]. These approaches to value-measurement 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.
Value- creation can also be achieved through financial restructurings wherever 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-Off. Organizational restructurings, such as downsizing, do not create value.Utilisation of Debt, wherever Debt Capacity exists, is a good means of restructuring towards value-creation
Tangible and intangible sources of value go beyond financial restructurings. They include factors like great customer service blend with efficient production operations. When a company can reinvent itself, like the way e-bay conducts auctions, it leads to value creation. The ability to engage in innovative strategizing and changing how things are done, is by far the greatest source of value-creation.Hence astute financial management approach can create firm value.
In case of any query the author can be contacted at soman-presidency.edu.in