Building Stakeholder Value

Profits arent enough Servicing capital providers

• Sustainable businesses need to earn consistent and predictable profits. But accounting profits alone are not enough. Lets say youre in the happy position of owning a profitable business outright, and your business managers are generating and reporting $1 million of annual profits and cash flows for you, the 100% owner. So far so good?
• Well, depending how much of your capital is tied up in the business, $1m annual profits might not seem so good after all. What if the net business assets were worth $1 billion 100 times as much as the annual profits? This business is using, and tying up, $1bn of your capital, that you cant deploy elsewhere. Your managers are only achieving a rate of return on your capital of $1m / $1bn = 0.1% per annum. You could probably achieve a greater rate of return for a similar level of risk by deploying the capital elsewhere.
• So as the business owner youll want to monitor your investment and your managers by the rates of return theyre achieving on your capital, as well as the $ amounts of profits. As business managers and project managers, we need, in turn, to understand our capital providers, and the rates of return our capital providers are quite reasonably requiring from their capital investments in the business were employed in.

Future value, Present value Net present value

• The amounts of reported profits and cash flows are fundamentally important. But so is their timing. $1m receivable tomorrow is better than $1m receivable in 10 years time. If we get $1m tomorrow, we might be able to use it a number of different useful ways. For example, we might be able to repay some borrowings earlier, and save interest expense. Or we might be able to deploy the $1m into another attractive investment opportunity.
• On the other hand, if we have to wait another 10 years to get our $1m, we wont have any of those attractive options open to us. So wed clearly prefer to collect our money earlier, assuming no difference in the amounts. This preference reflects the time value of money. But what if we had to choose between getting a smaller amount of $0.8m tomorrow, or the full $1m in 10 years time?
• Tools for making that evaluation include Future value, Present value, and Net present value. These project evaluaton tools are all Discounted Cash Flow (DCF) techniques, giving results in money terms. They factor in the timing of forecast cash flows as well as their amounts. And they also take account of the rates of return required by our capital providers.

Internal rate of return, Yield Total shareholder return

• Another group of Discounted Cash Flow (DCF) project evaluation techniques includes Internal rate of return (IRR). IRR summarises a set of cash flows as a single percentage figure. The IRR measure is independent of any investors required rate of return. The greater the positive percentage IRR figure, and all other things being equal, the more attractive the proposal for an investor. IRR can also be used to evaluate the cost of different financing proposals. The lower the IRR, the more cost effective the financing appears to be on this measure.
• Yield is one of the many words in finance with a number of different meanings. In the context of borrowing and financing, yield is the internal rate of return (IRR) of the borrowing or other financing cash flows. Yield is also a measure of the rate of return on an investment in tradeable debt, for example a corporate bond.
• Total shareholder return (TSR) is a measure of the rate of return enjoyed by investors in equity shares (shareholders). TSR takes account of the capital value of the shares over time, together with any dividends on the shares over the same period, and any other relevant cash flows for the shareholder. TSR is calculated as the IRR of these relevant cash flows. Many companies whose shares are listed on an exchange use TSR as a key performance measure for their senior managers.

Valuation, Market Book values

• Values and valuations are fundamentally important, but not always straightforward to quantify. Appropriate valuation techniques, and the values themselves, can depend on the circumstances, as well as the nature of the asset. One valuation method for a business is a DCF analysis of the entire enterprise.
• When a companys shares are listed on an exchange, the latest traded price per share is quoted continuously during trading hours. The total current market value of the (equity) shares is simply the share price multiplied by the number of shares. This total figure is sometimes known as the market capitalisation, to emphasise the perspective that the current market price of the shares might represent an overvaluation or an undervaluation by the market.
• Multiples valuation means comparing values, or estimating values, based on a mutiple of a relevant financial measure. Examples include PE ratios for a companys equity, and EBITDA multiples for the whole enterprise (the total of the companys equity and its debt). Market values imply a sale and purchase transaction, or a potential sale and purchase transaction, in the market. Book values, in this context, mean amounts reported in a companys financial statements. Book values and market values can differ substantially, with market values of successful companies often greatly exceeding their book values. Reasons for the differences include valuable intangible corporate assets, that are not recorded in traditional financial statements. Book values for large organisations are audited, adding to the credibility of the reported book values.

Growing and Safeguarding stakeholder value

• Growth enhances corporate value, while risk destroys value. Accordingly, managers can grow corporate value by appropriate sustainable growth of the future net positive cash flows of the business. In turn, this might flow from revenue growth, cost control or both assuming no change in related risk. Similarly, all other things being equal, applying risk management techniques to reduce the risk of future cash flows will increase their value, via a reduction in the required rate of return for the (now) lower-risk cash flows. In practice however, there will more often be a trade-off between improving or worsening forecast cash flows and related levels of risk. For example, discontinuing insurance cover will save insurance expenses, but increases the risk of suffering uninsured losses. The sustainability of the entire business, including its environmental sustainability, is increasing a key dimension of its stakeholder risk management. Stakeholders include shareholders.
• A more subtle way to enhance shareholder value is to reduce the amount of capital that the company needs in order to operate. For example, by better working capital management. An example would be improving trade credit terms negotiated with and applied to customers and suppliers. In a simple case, this might enable the company to return capital to its shareholders for them to deploy elsewhere, while continuing to generate profits in the company.
• The stakeholders in a business include its shareholders, but also an increasing wide group of other poeple, organisations and potentially other entities. For example, one life sciences business mentions its stakeholders as including customers, employees, suppliers, industry organisations, local and central governments, those who live and work where the business operates, and society as a whole. Companies are increasingly - and explicitly - taking account of the interests and capital value of all of these other stakeholders, and professional management of the companys relationships with them, and not just the companys own shareholders as in the past.