Value based divisional performance Flashcards
Cash v Profit
Managers are motivated and incentivised by profit whilst shareholders are motivated by growth in market value of shares
Profit is short term so focus is on ROI/RI whilst shareholders dividend is stimulated by cash.
Shareholder value added - definition, drivers, proforma
Value based techniques are of the idea to set targets for managers that align with shareholders interest
SVA suggests 7 value drivers and the business would set targets in each area that would be specific, measurable, achievable, controllable and measurable.
These drivers are the components of a typical NPV calculation hence linking targets to cashflow and NPV and so Market value of shares
Drivers/Comments
1. Revenue - controllable and a good target area
2. Operating Margin - margin is important and controllable
3. Tax rate - exogenous as tax planning is carried by H/O and govt
sets rate
4. Capital expenditure - poor cheap and poor quality assets might be
desirable
5. Investment in working capital - good working capital management
is good for cashflow
6. Cost of capital - cheap borrowing is desirable, raising finance is
mostly carried out by H/O
7. Period of growth in new projects - Longevity is not overly useful,
growth is positive
Value based management
Value is shareholder value or value in the businesses.
shareholder value is determined by the P.V of cashflows generated by a business discounted at the cost of money into perpetuity
VBM is about setting targets for the things that drive value in the business. It expects managers to understand their targets and target the right thing
The main thing is managers have to ask themselves how to generate cash and grow the business in the long term.
Four steps of VBM
1. Strategic development - strategy, business objectives and high
level drivers
2. Target agreed and set - For each driver a target is set, consistency
is key. short and long term must be considered - excessive focus
on long term can leave org short of cash and failure
3. operational ownership - each target is allocated to a responsible
individual, driven all the way to every employee
4. Performance is measured in the PMS
The big shift is emphasis on the creation of long term shareholder value as the focus of measures
Implementation issues
1. cultural shift will be required which people may resist
2. New systems might be needed to capture and report KPI
3. New KPI’s will be needed for each driver, which may be difficult to
get right.
Economic value added - Objectives, proforma, adjustments
EVA is theoretically the increase in market value of the business due to action of directors in managing the businesses results, it ignores M.V changes due to exogenous factors. it is a measure of performance in last 12 months not a decision making tool
Objectives - last 12 months
1. To provide a measure of returns more consistent with cashflows
2. to encourage a long term view
3. to reduce focus on book value of asset used in ROI/RI and move
towards M.V
Proforma
Cash profit (NOPAT) X
WACC on MV of assets (X)
EVA X
Use M.V of assets at the beginning of the year, positive value = value added, negative value -= value destroyed
Adjustments - Two adjustments for NOPAT and capital employed
1. Economic depreciation is used instead of depreciation (cost)
2. add tax relief from debt interest (cost)
3.
4.
5. Provisions are not allowed, add them back to capital employed
and P&L. Use closing balance to find P&L. OB - CB = P&L
6. Brand based marketing can be capitalised and amortised . Advertising is expensed
7. Research is capitalised and amortised.
Positives
1. Provides a cash focussed return
2. Removes the shortermist temptations around marketing and R&D
3. Moves from B.V to M.V
4.more closely aligns performance appraisal to shareholders needs
5.
Negatives
1.Very complicated to calculate
2. Information not always readily available
3. Trademarked by Mckinsey
