By – Prof. Soman Nambiar
School of Management,
Presidency University, Bengaluru
In needs no emphasis that every single stake holder has seen the Traditional Accounting Model as one that does not meet their true needs in firm value optimization. One needs to break his/her addiction to earnings and find other ways as 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 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.”
How a Manager manages his “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 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 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
Finally, tangible and intangible sources of value go beyond financial restructurings. They include factors like great customer service or extremely efficient production operations. When a company can reinvent itself, like the way IKEA sells furniture or the way e-commerce units conduct auctions, it leads to value creation. The ability to engage in innovative strategizing and change how things are done is by far the greatest source of value-creation. Hence astute financial management approach can create firm value