Value Based Management by gauravjindal

VIEWS: 93 PAGES: 15

									   A firm making profit is not a sufficient
    condition to ensure value creation for the
    shareholders. Unless these profits are
    adequate to compensate the opportunity cost
    of capital.
   Thinking beyond the earnings will ensure
    right conclusions.
   Most of us concentrate on the earnings of an
    enterprise as a measure of its performance.
  VBM is an approach that ensures that firms are
   run consistently on values rather than on
   profit. It includes way to-
(a) Create value, i.e., the strategies to increase
     future value;
(b) Manage the value, i.e., focus on change
(c) Measure the value i.e., EVA, MVA etc.


Creating value is not only confined to finance
   function, all functions of the firm get involved
   in the process of value creation.
 Under the VBM, the scope of each function is like;-
Marketing function stretches beyond increasing
  market value and revenue;
Production function has to think beyond increasing
  production;
Finance function is required to undertake investment
  strategies that channel the funds in the right
  avenues that go to create value.
Value is created only when firms invest capital in a
 manner that the recovers the cost of capital. It
    focuses on;
i)    Economic profits based on cash flows and surplus
      cash over cost of capital;
ii)   Identifying the key drivers of the value
iii) The use their own methods to measure value.
   VBM INSTILLS A MIND - SET WHERE EVERYONE IN
     THE ORGN … FOCUSES ON VALUE CREATION.
   • A COMPREHENSIVE VBM PROGRAM …
           STRATEGIC PLANNING
           CAPITAL ALLOCATION
           OPERATING BUDGETS
           PERFORMANCE MEASUREMENT
           MANAGEMENT COMPENSATION
           INTERNAL COMMUNICATION
           EXTERNAL COMMUNICATION
                    VBM represents…..
    a synthesis of various business disciplines
   Finance        : Goal of shareholder value maximisation
                     and the DCF model
   Business        : Value creation stems from exploiting
                      strategy opportunities based on the
                      firm’s comparative advantage
   Accounting     : Structure of financial statements with
                     some modification
   Organisational : Notion that ‘you get what you measure
                      and behaviour reward’
             METHODS / MEASUREMENT OF VBM
   Several methods have been used in VBM. The three
    principal methods of VBM are:
i) The free cash flow method proposed by McKinsey and
   LEK/Alcar group.


ii)The cash flow return on investment / cash value
  added (CFROI/CVA) method developed by BCG and
  Holt Value Associates.


iii) The economic value added / market value added
    (EVA/MVA) method pioneered by Stern Stewart
     and Company.
   CVA is the excess of cash generated over and
    above the requirement of cash. It is a cash flow
    based measure of value that includes only the
    cash items.
   CVA = Operating CFs – Operating CF Demand
         CVA = OCF – OCFD

OCF = EBITDA+Increse in Working capital
OCFD = Opportunity cost of capital demanded
       by the investors on strategic investment.
 CFROI is based on corporate performance and it as
  ratio of sustainable cash flow in a year to the cash
  invested on the assets of the firm.
              Sustainable cash flow
 CFROI = --------------------
                  Cash Invested
Sustainable CF –> is cash flow adjusted for economic
  depreciation.
Economic Profit is the annual amount of charge
  (Sinking fund) on the cash flows of the firm that is
  required for replacing the asset after its useful life
  is over and with discount factor of WACC of the
  firm.
 This approach makes adjustments for
  differences in capital structure, age and life of
  the assets, mix of the assets, and the
  investment needed to generate earnings.
 It is based on;
  profitability, competition, growth and cost of
  capital.
                      OCF – Capital Charge
Economic Margin = --------------------
                        Invested capital
OCF = Net income + Depn. & amortizaton +
       after tax interest + R&D expenses +-
       Non recurring expenses or income

Invested Capital = Total assets + Accumulated
                   depn + Gross plant inflation
                   adjustment+capitalized R&D
                   - Non debt CL
   It is an excess of market value of the firm as
    reflected in share price and the value of the
    debt, over the book value of the capital
    employed.

MVA = MV of the firm – Capital employed

It represents the excess of what the investors
  can get over what they have put into
  business.
   It is based on the value addition in excess of
    investors expectation of return. It measures
    the profit that is earned over and above the
    cost of capital of the firm.
   It is the residual income operating profits after
    the cost of capital has been earned. It can be
    stated that;

EVA = Return on total capital employed – Cost
         of capital x Total capital
It recognize the efficiency of capital along with
  profits. It incorporate both equity & debt of the
  capital.
 1. Compute the NOPAT (Profit before tax Less
  taxes Add Actual Interest after tax)
 2. Find out WACC
 3. Find EVA
It may be calculated in any of the following ways;

EVA   =   NOPAT – c* x Capital
EVA   =   Capital ( r – c*)
EVA   =   [ PAT +INT(1-t) ] – c*Capital
EVA   =   PAT – ke Equity
Illustration : pp 829 – 830
- End -

								
To top