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Businessmen should focus on Shareholder Value Analysis

Dr. Forster Kum-Ankama Sarpong


Shareholder value is a business term, sometimes phrased as shareholder value maximization
or as the shareholder value model, which implies that the ultimate measure of a company's
success is the extent to which it enriches shareholders. It became popular during the 1980s,
and is particularly associated with former CEO of General Electric, Jack Welch. In essence, the
idea that shareholders' money should be used to earn a higher return than they could earn
themselves by investing in other assets having the same amount of risk.
Dr. Forster Kum-Ankama Sarpong, emphasizes that managers of small, medium and large
enterprises (SMiLEs) need to pay attention to their shareholders value if they want to derive
the full financial returns for which the company was established. He said that in business the
primary objective of company directors must be to maximize the wealth of the company's
shareholders.
SVA is employed to determine the value of a company by looking at the returns it gives to
shareholders, and is based on the view that the objective of company directors is to maximize
the wealth of the company's shareholders. Dr. Sarpong has defined the basic concepts as used
in the financial calculations involved in carrying out SVA and recommends on its
implementation.
According to Dr. Sarpong, in recent years, traditional financial methods for calculating the
value of a business have been criticized for being either too short-term or measuring only what

has happened in the past. Business decisions based on traditional accounting methods of
value, such as earnings per share, growth in profits or return on equity, are increasingly seen as
being flawed for these reasons. SVA takes a longer-term view, and is about measuring and
managing cash flows over time.
SVA is a method of financial analysis which measures shareholder value. This is done by
estimating the total net value of a company and dividing this figure by the value of shares. The
result is the shareholder value of the company. The fundamental principle underlying concepts
of shareholder value is that a company adds value for its shareholders only when equity returns
exceed equity costs. Once the amount of value has been calculated, targets for improvement
can be set and shareholder value can be used as a measure for managing performance.
SVA provides a long-term financial view on which to base strategic decisions. It also provides a
universal approach that is not subject to the particular accounting policies that are adopted. It
is therefore internationally applicable and can be used across sectors. It forces the organization
to focus on the future and its customers, in particular the value of future cash flows.
There are however some few challenges to the application of the SVA. Estimation of future
cash flows, a key component of SVA, can be extremely difficult to complete accurately. This
can lead to incorrect or misleading figures forming the basis for strategic decisions.
Development and implementation of a system can be long and complex. Communication of
the approach to managers can be difficult and management of shareholder value requires
more complete information than traditional measures.
It is important when planning to adopt shareholder value as a significant financial objective
that you understand the implications and best approach for your business. This can be
achieved by planning the approach first with professional advisers, such as accountants or
consultants who specialize in this area. A company's shareholder value can be calculated as
follows:
Shareholder value = Total business value - Debt
In other words, the value given to shareholders is found by subtracting the market value of any
debts owed to the company from the total value of the company. The 'total business value' has
three main components namely the present value of future cash flows during a planned period,
the residual value of future cash flows from a period beyond the planned period and the
weighted average cost of capital.
This is represented as the total business value =
Present value of future cash flows + Residual value of future cash flows
Weighted average cost of capital

If the result of this equation is greater than one, then the company is worth more than the
invested capital and value is being created.
o Future Cash Flows: Future cash flows are affected by growth, returns and risk, sales
growth rate; operating profit margin; income tax rate; working capital investment; fixed
capital investment; cost of capital and value growth duration.
o Residual Value: The residual value is an important figure, which represents cash flows
arising after the normal planning period. It has been estimated that as much as two thirds
of the value of a business can be attributed to cash flows arising after the normal planning
period.
o Weighted Average Cost of Capital (WACC): WACC consists of the cost of equity added to
the cost of debt, and its purpose is to express the return that a company must earn if it is to
justify the financial resources that it uses.
Additionally, SVA is based on the belief that creation and maximization of shareholder value is
the most important measure by which to assess business performance. This overriding
objective must be accepted by top managers for it to be achieved and take root in the
organization. There should also be an acceptance that traditional measures and approaches
may fall short of achieving this objective.
Managers need to understand the broad nature of creating shareholder value, particularly
when appraising potential projects, but the technical aspects of SVA are unlikely to be of
concern. Managers need to understand the importance of identifying, controlling and
improving the performance of the value drivers, and the key factors influencing them.
Adoption of SVA and setting of new targets will probably challenge managers' existing habits
and approaches, and as a result may cause resistance. Previous approaches will need to be reevaluated and possibly discarded in favour of new targets.
Unlocking shareholder value is essentially a change process, and it requires line managers (who
are invariably the people making the key operational decisions) to be fully trained. It is also
important when implementing an SVA approach to achieve early, high profile successes. As
with any change process, early successes will demonstrate the value of the new approach,
highlighting the benefits and winning over sceptics.

About the Author:


Dr. Forster Kum-Ankama Sarpong is the CEO of All Ghana Microfinance and a lecturer in
Finance and Quantitative Models. (E): fosarpong@yahoo.com