University of Cambridge’s brings course “Building stakeholder value”. During this five-week course, you’ll not only learn about the fundamentals of finance, but you’ll also learn how to apply them to your own business.
It’s essential to know how profits are calculated to have a sustainable business. In the following sessions, we’ll look at various accounting methods and approaches to determining a company’s value:
- Profits aren’t enough – servicing capital providers
- Future value, Present value and Net present value
- Internal rate of return, Yield and Total shareholder return
- Valuation, Market and Book values
- Growing and Safeguarding stakeholder value
What matters is that this course will clear up any lingering questions you have about your company’s key performance indicators (KPIs), including total shareholder return, as well as the numbers associated with your capital investments.
What you’ll learn
On completion of the Building stakeholder value course you will understand:
- Project evaluation & discounted cash flow techniques
- Net present value, internal rate of return, and total shareholder return
- Market values and book values
- What traditional accounting misses out
- Shareholders and other stakeholders
1. Profits aren’t enough – Servicing capital providers
Businesses that can sustain themselves long-term must consistently and predictably make money. It’s not enough to look at the financial results. Suppose you’re the sole owner of a profitable company, and your business managers are reporting and generating $1 million in annual profits and cash flows for you. Is everything going well so far?
$1 million in annual profits may or may not seem like a good deal. It depends on how much of your money is invested in the business. Assume that the company’s net assets totaled $1 billion, which is 1,000 times greater than the annual revenue. One billion dollars of your money is locked up in this business, which you can’t use elsewhere. You’re getting only a 0.1 percent annual return on your $1bn of capital from your managers. To get a higher rate of return for the same level of risk, you may be able to invest the money elsewhere.
This means that as a business owner, you should keep tabs on your investment and your managers’ profit margins and rates of return. It is our responsibility as business leaders and project managers, in turn, to understand our financial backers and the rates of return they expect from their capital investments in the company we work for.
2. Future value, Present value & Net present value
The amount of profit and cash flow that has been reported is critical. However, their timing is impeccable. It is better to have $1 million in receivables today than $1 million in ten years. We may be able to put $1 million to good use in various ways if we get it tomorrow. We may save money by paying off some of our debts earlier, for example. Perhaps we can invest the $1 million in a more attractive investment opportunity.
If we have to wait another decade to receive our $1 million, on the other hand, none of those exciting possibilities will be available to us. Assuming there is no difference in the amounts, we would prefer to collect our money sooner than later. The time value of money is reflected in this preference. On the other hand, suppose that we had to choose between getting $0.8m today and getting $1m in 10 years.
Future value, present value, and net present value are all valuable tools for this type of analysis. DCF techniques are used in all of these project evaluation tools, and the results are expressed in dollars. They consider both the amount and the timing of anticipated cash flows. The return rates required by our capital providers are also taken into account.
3. Internal rate of return, Yield & Total shareholder return
DCF project evaluation methods also include the internal rate of return (IRR) (IRR). The IRR is a single percentage figure that sums up all of the cash flows in a period. Independent of any investor’s desired return, the IRR is calculated. The more attractive a proposal is to an investor if the positive percentage IRR figure is more significant, all other things being equal. IRR can also be used to compare the costs of various financing options. The lower the IRR, the more cost-effective the financing appears to be on this measure.
Many words in finance have multiple meanings, and yield is no exception. When borrowing and financing, yield is the internal rate of return (IRR) of the borrowing – or other financing – cash flows. An investment in tradeable debt, such as a corporate bond, can also be measured by its yield.
The total return to shareholders (TSR) is a metric used to assess the profitability of equity investments (shareholders). TSR considers the capital value of the shares over time, any dividends paid on the claims, and any other relevant cash flows for the shareholder. The IRR of these cash flows is used to calculate TSR. TSR is a key performance measure for many companies whose shares are traded on an exchange.
4. Valuation, Market & Book values
There are fundamentally important values and valuations that can be difficult to quantify. The circumstances and the asset’s nature can influence the appropriate valuation techniques and the values themselves. One way to value a business is to perform a DCF analysis of the entire organization.
When a company’s stock is traded on an exchange, the most recent sold price per share is always available. A company’s current market value is simply the current share price multiplied by the number of shares in issue at present. The total amount is sometimes referred to as market capitalization because of the possibility that the current share price represents a market overvaluation or undervaluation.
Valuing multiples involves comparing and estimating values based on a multiple of an appropriate financial measure. PE ratios for a company’s stock and EBITDA multiples for the entire company (the sum of the company’s equity and debt) are two examples. Values in the market indicate a sale and purchase or a potential sale and purchase. In this context, “book values” refers to the amount of money a company reports in its financial statements. Book values and market values can differ significantly, with successful companies’ market values often exceeding their book values. Important intangible corporate assets, which aren’t typically recorded in traditional financial statements, may be blamed for the discrepancies. As a result, the reported book values of large organizations are more trustworthy.
5. Growing and Safeguarding stakeholder value
The value of a company rises when it grows, but the value is lost when it takes risks. This means that managers can increase the company’s value by ensuring that future net positive cash flows continue to grow in the way they think they should. As a result, this could result from increased revenue or cost control, assuming there is no change in the associated risk. Applying risk management techniques to reduce future cash flow risks will increase their value by lowering the required rate of return for those (now) lower-risk cash flows. Similarly, all other things are equal. It’s more likely that improving forecast cash flows will come at the expense of higher associated risk levels in the real world. Insurance costs can be reduced by not purchasing protection, but the potential for uninsured loss is increased. Stakeholder risk management is becoming increasingly concerned with the company’s long-term viability, including its environmental sustainability. Shareholders are part of the stakeholder group.
To increase shareholder value more subtly, a company can reduce the amount of capital it requires to operate. Among other things, this can be done by improving working capital management. Improved trade credit terms for customers and suppliers could be an example of this. This may allow the company to return capital to its shareholders, which they can then use to invest elsewhere while also allowing it to continue making money.
A company’s stakeholders include its shareholders and a growing number of other people, organizations, and possibly other entities. One life sciences company, for example, has customers, suppliers, industry organizations, and local and central governments, as well as those who live and work in the business’s service area. Professional management of the company’s relationships with all of its stakeholders, not just its shareholders, is becoming increasingly important to companies – and this is stated explicitly.