BUSF_A01.qxd

Value-based management

Corporation tax rate

The corporation tax rate clearly affects cash flows and value because, broadly, tax is

levied directly on operating cash flows. Management’s ability to influence the tax rate

and the amount of tax paid by the business tends, at best, to be marginal.

Investment in non-current assets

Normally, cash has to be spent on additional non-current assets in order to enhance

shareholder value. Wherever managers can find ways of reducing the outlay on plant,

machinery and so on, without limiting the effectiveness of the business, this will tend

to enhance shareholder value.

Investment in working capital

Nearly all business activities give rise to a need for working capital (inventories, trade

receivables, trade payables and cash). As we shall see in Chapter 13, the amounts tied

up in working capital can be considerable. Steps that can be taken to reduce the

investment in working capital, such as encouraging credit customers to pay more

quickly than expected, will bring cash flows forward and tend to generate value. We

shall consider many of these steps in Chapter 13.

10.2 Cost of individual capital elements

The cost of funds used to finance the business’s activities will typically be a major

determinant of shareholder value. So, if the business could find cheaper sources of

long-term finance, value would tend to be enhanced. How this would be achieved is

discussed later in the book, particularly in Chapters 8 and 11.

The life of the projected cash flows

Clearly, the longer that any cash-generating activity can continue, the greater its

potential to generate value.

How can SVA be used?

Probably, SVA’s most helpful contribution to managing the business is that it high-

lights the key drivers of value. This enables managers to set targets for achieving

value-enhancing strategies in each area. It can help to create an environment where

value enhancement is at the top of the agenda for managers in all areas of the business.

In this way the primary financial objective of the business is linked directly to man-

agers’ day-to-day decisions and actions.

SVA can be used as a basis for valuing shares and, thereby, assessing the increase

in shareholder value as a result of adopting particular strategies. Doing this, however,

tends to rely on making some simplifying assumptions that rather call the results into

question.

An assessment of using the SVA approach to management

SVA’s positive points include:

l SVA encourages managers to take actions that will lead to enhancement of share-

holder value, so that their actions link directly to the principal corporate objective

of most businesses.

l Managerial targets can be set in the area of each value driver.