LATEST TOOLS AND
Dr. Navita Nathani
Chief Coordinator EDC
Prestige Institute of Management, Gwalior
Overview of the subtopics
Tools of Wealth maximization and SVC
Tools of Working Capital Management
Tools of Capital Budgeting
With the liberalization of Indian economy, the
Indian corporate world has found itself in an
environment where it has to contest with the market
forces, large corporations with significant brand
equity and also follow different resource strategies
India faces the task of not only integrating itself
with the rest of the world, but more importantly, of
understanding future global trends to work towards
finding a place among the leading economies.
It is widely accepted that the primary aim of the firm is to
maximize the wealth or it is generally agreed that the goal of
the firm should be Shareholders Wealth Maximization
From the economist's viewpoint, value is created when
management generates revenues over and above the economic
Costs come from four sources: employee wages and benefits;
material, supplies, and economic depreciation of physical
assets; taxes; and the opportunity cost of using the capital.
It is therefore more important to know the variables which
influence value addition.
Today, financial managers play a dynamic role in solving complex
Shaping the fortunes of the enterprise,
Decisions regarding allocation of capital,
Raising of funds most economically and using them in the most
efficient and effective manner.
Because of this change , the descriptive treatment of the subject of
financial management is being replaced by growing analytical contents.
The subject now accords a far greater importance to management
decision-making and policy.
Hence new tools in financial management emerged. It comprises of
Tools and techniques in
Financial Analysis, Profit Planning and Control
Long-term Investment or capital budgeting Decisions
Working Capital Management
Why Value Addition
Creating value for shareholders is now a widely accepted corporate
objective. The interest in value creation has been stimulated by several
Performance measurement (qualitative or quantitative) is the key to value
Capital markets are becoming increasingly global. Investors can readily
shift investments to higher yielding, often foreign, opportunities.
Institutional investors, which traditionally were passive investors, have
begun exerting influence on corporate managements to create value for
Corporate governance is shifting, with owners now demanding
accountability from corporate executives. Manifestations of the increased
assertiveness of shareholders include the necessity for executives to justify
their compensation levels, and well-publicized lists of under performing
companies and overpaid executives.
Greater attention is being paid to link top management compensation to
Creating shareholder value is the key to success in
There is increasing pressure on corporate executives
to measure, manage and report the creation of
shareholder value on a regular basis.
In the emerging field of shareholder value analysis,
various measures have been developed that claim
to quantify the creation of shareholder value and
Financial Performance Measurement
Traditional Vs New Economic Measures
ROE, ROI, EPS, NOPAT, and OP.
New measures are given by different consultant
from time to time
It include lot many approaches
Marakan Associates, an international management-
consulting firm founded in1978, has done
pioneering work in the area of value-based
This measure considers the difference between the
ROE and required return on equity (cost of equity)
as the source of value creation.
The Alcar group Inc. a management and software company, has
developed an approach to value-based management which is based
on discounted cash flow analysis. In this framework, the emphasis
is not on annual performance but on valuing expected performance.
The implied value measure is akin to valuing the firm based on its
future cash flows and is the method most closely related to the
With this approach, one estimates future cash flows of the firm over
a reasonable horizon, assigns a continuing (terminal) value at the
end of the horizon, estimates the cost of capital, and then estimates
the value of the firm by calculating the present value of these
estimated cash flows. This method of valuing the firm is identical to
that followed in calculating NPV in a capital-budgeting context.
McKinsey & Company a leading international consultancy firm has developed an
approach to value-based management which has been very well articulated by Tom
Copeland, Tim Koller, and Jack Murrian of McKinsey & Company. According to
Properly executed, value based management is an approach to management
whereby the company's overall aspirations, analytical techniques, and management
processes are all aligned to help the company maximize its value by focusing
decision making on the key drivers of value.
The key steps in the McKinsey approach to value-based maximization are as
* Ensure the supremacy of value maximization
* Find the value drivers
* Establish appropriate managerial processes
* Implement value-based management philosophy
THE DISCOUNT CASH FLOW
The true economic value of a firm or a business or a project or any strategy
depends on the cash flows and the appropriate discount rate
(commensurate with the risk of cash flow). There are several methods for
calculating the present value of a firm or a business/division or a project.
The first method uses the weighted average cost of debt and equity
(WACC) to discount the net operating cash flows. When the value of a
project with an estimated economic life or of a firm or business over a
planning horizon is calculated, then an estimate of the terminal cash flows
or value will also be made. Thus, the economic value of a project or
Economic Value=Present Value of net operating cash flows+ Present
value of terminal value
ECONOMIC VALUE ADDED
Consulting firm Stern Steward has developed the concept of
Economic Value Added. Companies across a broad spectrum
of industries and a wide range of companies have joined the
EVA badwagon. EVA is a useful tool to measure the wealth
generated by a company for its equity shareholders. In other
words, it is a measure of residual income after meeting the
necessary requirements for funds.
Computation of EVA
EVA is essentially the surplus left after making an appropriate
charge for capital employed in the business. It may be
calculated by using following equation.
EVA= Net operating profit after tax- Cost charges for capital
Market Value Added
Market value is referred to as the “Enterprise
value”. It is the total of the firm’s market value of
debt and equity
SVC is also referred to as MVA
Market value added = Market value- Invested
MV increases only in case firm earns returns in
excess of the cost of capital
Balance Score Card
No manager can ignore the bottom line the key indicator of
what has happened that is a “lagging indicators”. How well
you are doing i.e. “current indicator” and “leading indicators”
that means what can expect to do in the future ?
For this we need a more comprehensive view with an equal
emphasize on three important indicators. Indicators that
clearly measures performance against objectives and can help
you to set specific ,realistic, measurable and time bound
targets so you get where you want to go.
Balance Scorecard is a way of
Measuring organizational business unit or dept.
Balancing long term & short term actions
Balancing different measures of success
Innovation & learning
EVA as tool for measuring the
The study was empirical and descriptive in nature.
The total population was Indian banks which are
listed in NSE-50.The sample frame were individual
banks during the year 2005-06.
The sample sizes were five Indian banks selected on
the basis of the convenience sampling technique.
The data was collected through secondary resources
i.e. websites of NSE.
Objectives of the Study
To calculate shareholders return using EVA.
To calculate shareholder’s return using traditional
measures (by OP, EPS, ROE, ROI)
To determine the most accurate method of calculating
To compare shareholder’s return calculated through EVA
and traditional measures.
To see correlation between EVA and traditional
To open new vistas for further research.
Empirical findings are different from
the views of consultant
Ho = EVA is the best measure to evaluate the stock
ROI ROE EPS G PROFIT EVA
0.1 0.16 29.2 67794947 -276433162
0.112 0.16 27.92 13396615 -312728000
0.12 0.11 32.49 39078072 -108772675
0.115 0.17 17.45 7462826 -320172274
0.057 0.11 27.1 12722456 -65259714
-0.57273 -0.98481 0.506888 0.002638312
Results of Correlation between EVA and other Variable of
It is evident from this table that the only variable with which EVA
strongly correlates is EPS and with returns on investment and return
on equity it is showing negative correlation.
Because of the negative EVA the correlation between EVA and ROI
is -.57 and between EVA and ROE is -.98.
Then it shows that there is no relation between EVA and return on
equity and return on investment. So if any bank has higher earning
per share then we can assume that bank is focusing on value
creation and rewarding banks which increase shareholder value.
The results are in alignment with Fernández (2001) who had
calculated using EVA, MVA, NOPAT and WACC data for 582
American companies provided by Stern Stewart. For each of the
582 companies there are 210 companies for which the correlation
with the EVA has been negative.
Items ROI ROE EPS O.P EVA
ROI - -7.815 -1.361 .990 7.581
ROE -.128 - -.174 0.127 -.970
EPS -.735 -5.742 - 0.728 -5.570
OP dependent 1.010 7.890 1.374 - -7.655
EVA .132 1.031 0.180 -.131 -
Accurate method of measuring the shareholder’s
For measuring the accurate method of performance
the regression was applied among various variables
(ROI, ROE, OP, EPS, and EVA).
The value of beta is higher in the case of operating
profit and hence it can conclude that the operating
profit, which is a traditional measure, still is the best
method of measuring the shareholder’s wealth.
After that ROE is the second best method then EPS
and ROI respectively.
Working capital management
Many companies still underestimate the importance of
working capital management as a lever for freeing up
cash from inventory, accounts receivable, and Payables
By effectively managing these components, companies
can sharply reduce their dependence on outside
funding and can use the released cash for further
investments or acquisitions.
This will not only lead to more financial flexibility, but
also create value and have a strong impact on a
company’s enterprise value by reducing capital
employed and thus increasing asset productivity.
Value creation vs. working capital management: A study of manufacturing companies
The present study was empirical in nature and was
conducted on manufacturing companies by considering
sample of about 35 manufacturing companies listed in NSE
50 from duration 2005-2008.
For evaluating the degree of relationship between net
working capital and profitability and between net working
capital and investment, correlation was applied. Moreover,
Descriptive statistics was applied to know the distribution
pattern of net working capital, investment and ROI. And
also Non – parametric Mann Whitney U test was applied to
know the significant difference between the above
variables. and all such calculations and testing was done by
using SPSS Statistical software.
There is significant difference between Net working
capital and ROI of manufacturing companies.
There is insignificant difference between ROI and
investment of manufacturing companies.
If these two hypotheses are true, then companies will
always try to reduce their NWCValue and wc.doc
balances and increase their investments with a view to
enhance companies’ profitability and ultimately create
value for them.
The findings indicate that Net working capital and ROI, Net
working capital and Investment are negatively correlated to
The results show that firms are specifically for two years
following this strategy but do not follow the above guidelines
for another 2 years that’s in year 2006 and 2008. This is due to
the downturn in economy.
This shows that firms are reducing their holdings on working
capital and thus results in enlarging investment and ROI.
Thus, it can be concluded that Management of working capital
in a strategic mode is now contributing to the value based
management systems and with the help of that manufacturing
companies under study are creating value for them. This is
facilitating the manufacturing companies to manage their
working capital in a new route instead of following the
Cash management – Cash Concentration and
controlled disbursements through zero balance
Inventory management- MRP, JIT and Kanban
Cash Collection –Factoring , lock boxes
Credit- Credit scoring - five c’s
Capital Budgeting Techniques
Discounted cash flow techniques
Net Present Value
Internal Rate of return
Non-discounted cash flow techniques
Average Rate of Return
Discounted pay back period
Today the old adage “if you can’t measure it , you
can’t manage it” has been taken to a new extreme
in many organization the result is confusion.
When there was a single overriding indicator, such
as profit /ROI it was relatively easy for manager to
know what they were supposed to achieve.
In these days of multiple measures, all of which are
assumed to be equally important its no longer clear
to many people where the organization’s priorities
However in lot many cases the empirical evidences
are quite different from the views of consultants.
There are n no of tools but the need of the hour is to
identify the important indicators of the organization
& implement that part which is necessary for the
organization point of view.
Lastly research and development activities may help
the organization in adopting and not adopting a
particular tool , which is possible through industry
Alfred Toffler has rightly said that
“In 21st century the illiterate person is not that person
who is not able to read and write but the person
who is not able to learn”.