The three underlying components of shareholder value are your company’s ability to generate cash flow, your company’s risk profile and the amount of invested capital in your company.
When you make a business decision all three of these factors will be affected which in turn will affect shareholder value. So to increase shareholder value you need to be aware of the effects that your decisions will make on these three items.
So if you were considering growth, well that might improve cash flow, but may expose you to more risk or may require an injection of capital which may overall decrease the shareholder value.
So when faced with growth, what needs to happen is that you need to increase your intangible value to offset the negative effect that growth will have on your shareholder value.
When you have intangible value your company will be worth more than its invested capital and its return on capital will be in excess of market rates. It means that your company is doing something better than its competitors or something that will set it apart from its competitors. Some things that can contribute to intangible value are having a well-recognized and trusted brand name.
I’m sure that you can all think of at least one. Perhaps you have a reputation for delivering high quality products and services, or have a skilled and trained workforce that would be difficult to replicate.
Perhaps you are located in a central location where your distribution costs are low. You could be in an industry that requires certification or licensing from a government body that serves as a barrier for competitors.
Perhaps you have modified your production equipment to make it more efficient than your competitor. All of the above are kinds of things that will provide you with competitive advantage.
So if you have a strong reputation or brand name recognition you could possibly charge a premium for your brand which would increase cash flow increasing intangible value which in turn increases shareholder value.
If you wanted to reduce risk, you could develop relationships with your major customers that would make it very difficult for them to get a similar product or relationship elsewhere reducing the risk of customer turnover.
If you wanted to reduce your capital requirements, you could manage your working capital more efficiently than your competitors as was seen in the late 1990s with the implementation of ‘just-in-time’ inventory systems.In order to realize the benefits of your competitive advantage and create the intangible value, the competitive advantage needs to be sustainable over the medium to longer term and also be transferrable to a new owner.History has taught us that any competitive advantage a company has right now can usually only be sustained over the short term because as soon as your competitors find out what you are doing and how, they will begin to do it as well.
So in order to continue to hold competitive advantage for a medium and longer term means that your company needs to continually adapt and innovate its products and services to always be one step ahead of your competition.
There are many ways of doing this such as implementing continuous product and service improvements in manufacturing, delivering and servicing the product. If you have a brand name, that name needs to be promoted and protected at all times.
You need to find ways to retain your employees so that they are with you for the longer term.If you should decide to sell your firm, the competitive advantage that you have developed should also be transferrable to the new owner. Most people will pay a premium for the competitive advantage that you have created provided that they can continue to have that same advantage after you are no longer a part of the company.
Assets, trademarks and patents are all transferrable to a new owner but customer and employer relationships are not which is why it is better to have a customer be loyal to the company rather than to a specific employee. Many business owners are too involved in their own companies and become the main contact person for the major clients.
This causes problems when they want to retire because they will not be able to retire without some possibly devastating consequences to the business. Business owners should make sure that the company will run with or without their involvement, something really difficult to accomplish when you have poured your heart and soul into the company.
To determine if your business could be affected by this issue, make a list of your top 10 customers and analyze whether they would continue to do business with the company after the ‘key’ person has retired or left.
Gabriele Banka, is a CPA CGA and the owner of Banka & Company in Kelowna