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Shareholder Value-Based Financial Planning
It is critical to measure a company's
success in creating shareholder value however "reengineering" of the financial
function although greatly publicized, in practice has become a euphemism for
"expense management". Companies are using an antiquated system of balance
sheets, income statements and cash flows to make decisions in a complex business
environment where the essential assets that create value have fundamentally
changed.
"The ability to leverage
physical and financial assets is limited and getting more so.
The ability to leverage human capital, structural or
intellectual capital (patents, productivity gains, quality
gains amongst others) and consumer capital (brand equity
amongst others) is unlimited and getting less so. An airplane
can fly on just one route. A reservation system is limited
only by the number of people in the world."
- Baruch Lev
Caplix Partners believes one key element
of instituting shareholder value creation as a discipline
within companies is to have a set of surrogate financial
metrics that supports all the major value-based approaches.
This element is essential to direct management behavior toward
value creation - since it provides a measurement of
achievement and links value-based financial metrics to
strategic objectives.
Value-based planning and management
approaches have emerged in a growing number of companies in
the United States and abroad. Measures such as Economic
Profit, Cash Flow Return on Investment, and Economic Value
Added provide insights into shareholder value creation (or
destruction).
After making these calculations, some of
the new believers may ask, "So what's next?" They should have
serious questions. "How do we translate these value measures
into more easily understood terms and establish simple,
value-based financial targets?" "In essence, what simple
expressions of operating performance link to stock price?"
"How can we integrate these concepts into our process for
developing strategic and operating plans?" "What surrogate
financial measures should we focus on to determine progress
toward value creation?"
Working value-based metrics into the
business units within a company can be a tricky task. It also
can present a dilemma, since some powerful and vocal
shareholder groups are pushing for the adoption of these new
performance measures. As a result, wise managements are giving
these methods serious consideration.
An initial step in helping managers
institute sophisticated metrics is to break down overall value
assessments into more basic financial elements, or drivers.
Three such drivers head a list of financial factors business
managers can influence that have a significant impact on
shareholder value. These three drivers collectively encompass
virtually all the key financial implications of operating a
business. How these indicators work together often determines
financial success or failure. This set of financial drivers
encompasses:
Growth Rates
Invested Capital Intensity, and
Value Profit
MarginTM
These three elements are applicable to
all the major value measurement approaches. So, whether you're
an EVA fan or CFROI addict, you can saddle up and take a ride
through the surrogates that drive the major value measures.
There are no metric wars here - only clarity and simplicity.
We believe a set of financial drivers is
a useful template for instilling shareholder value creation as
a motivating force in any for-profit enterprise, and should be
an integral part of a comprehensive value-based system. Our
templates of supporting metrics can also complement one or
more nonfinancial measures that a business strategy may
dictate.
An integrated strategic plan must
however, determine the prioritization and emphasis for
specific financial drivers and compensation metrics when you
are measuring the company's ability to produce an economic
profit and the company's share of the new wealth created in
your industry.
Can we help? We think so. We wrote the book on Financial Planning. Put us to the test.
Getting It Right – A Template for Creating Real Value – Roy E. Johnson
Read the first chapter. Click Here!
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