Professional Reference: Corporate Finance & Defining Value
This section explores corporate finance's foundations, detailing how businesses create value for shareholders, mainly through Total Shareholder Return (TSR). It outlines strategies like optimizing ROCE and efficient capital use. Key financial metrics like WACC and Excess Return are defined. Finally, it examines "value" from business, customer, and organizational perspectives, highlighting their alignment for success.
Corporate Finance & Defining Value
This section focuses on the financial underpinnings of business management, key metrics, and the drivers of corporate value.
4.1 Fundamentals of Value Creation in Business 📈
The ultimate aim of a commercial enterprise is typically profitable growth. Value is delivered to shareholders primarily through Total Shareholder Return (TSR), which includes capital appreciation and dividends.
Key strategies for value creation include:
- Optimizing Return on Capital Employed (ROCE) to exceed the Cost of Capital.
- Building a strong Brand and Reputation.
- Cost Reduction through process optimization, robotization, and digitalization.
- Avoiding Commoditization by focusing on "High End" solutions and the customer's "Job to be Done".
- Efficient Capital Employment by reducing fixed assets and Net Working Capital.
4.2 Key Financial Metrics & Value Drivers 🔑
- Return on Capital Employed (ROCE):
ROCE = EBIT / Capital Employed. Measures a company's profitability and capital efficiency. - Net Working Capital (NWC):
NWC = Current Assets - Current Liabilities. Measures a company's operational liquidity. - Cost of Capital (WACC): The minimum rate of return a company must earn to justify an investment. It is used as a hurdle rate for investment decisions.
- Total Shareholder Return (TSR):
TSR = (Current Price - Purchase Price + Dividends) / Purchase Price. Measures the total return an investor receives from a stock. - Excess Return:
Excess Return = ROCE - Cost of Capital. Directly measures the value created above the cost of capital.
4.3 Defining Value: Business, Customer, and Organisational Perspectives 💎
The concept of "value" can be interpreted differently depending on the stakeholder.
- Business Value: Encompasses anything that makes it easier for the business to achieve success, often translating to financial outcomes. Defined by executives.
- Customer Value: Refers to anything that makes the customer more successful or solves their problems. Defined by product and marketing teams.
- Organisational Value (Internal Value): Relates to anything that makes the job of other teams within the organization easier or more efficient. Defined by internally-facing teams.
These three perspectives are interconnected and should be aligned for sustainable success.