C-Suite Advisory

Measuring Financial Performance, Uninterrupted, from Start to Finish

Beyond the point of no return, the investor’s cash flow-based perspective is substituted with the accountant’s accrual accounting perspective. That is the way it is. This article shows you the way how to bridge the gap between ‘strategic investment’-evaluation and the (improved) measurements of traditional accounting, the best of both worlds.

Neither EVA® nor CVA®, but NVA, Net Value Added. Whether periodical or all together at t = 0. NVA (period) is the proven net profit in any given period, less demand. NPV-calculations, exclusive of SVD i.e. Substantial Value Difference, are incomplete and traditional accounts suffer from a lack of proof. Inclusive SVD right from the start, one can calculate more realistic economic life cycles, better standard unit-costs, and the expected NVAs both for each and every period and altogether at the point of no return.

Profit is a result. It starts with an investment generating cash. After deduction of value differences and taxes, net profit remains. It is all interrelated. Besides control on the route and overall profit judgment afterward, profit relates primarily to the capital budgeting decision; the ‘go/no go decision regarding a strategic investment proposal.

Cash flows alone are not decisive. Investments, depreciation each period, and profits form a trinity. An integral approach is imperative. By measuring subsequent net period profits in conjunction with the NVAs as accurately as possible after done investments, one can have the corporation at one’s fingertips.

Triggering the whole operation. At the least little indicator, one can give appropriate guidance on the necessary adjustment required. By not knowing the real period profit, one loses control. Up until now, managers have run their companies from the back seat. From sheer necessity, lacking a decent financial standard. At long last, The Profit Formula® puts them (and you) in the driver’s seat. Analogous to the law of conservation of energy in physics, the law of preservation of value holds true in economics, a natural law (see footnote 1). No value can appear nor disappear just like that.

The NPV/IRR method (including the models that are based on it, for instance, the CVA® concept) neglects substantialism. The present value method c.q. the method of the internal rate of return (not two measures of investment worth as it is reported in many textbooks but just one single method (see footnote 2), fails in numerous cases in making sound capital budgeting decisions. This is because of the fact that the NPV/IRR method meets only nominalism. It is providing for NVD, and maybe for SVD general as well, for instance by using an alternative rate, but it does not contain SVD specific.

Measuring financial performance, uninterrupted, from start to finish. Higher operating surpluses, above the red line (see footnote 3), will result in higher net profits operational and higher net profits in total respectively, and also a positive NVA altogether at t = 0. The operating surpluses in subsequent periods, totally, are what matters; they can be spread over the periods in many different ways.

Of course, one has to do the utmost in order to arrive at the best possible pattern. Strategic investment proposals must normally be underpinned thoroughly. Assessing NVA (that is valid in the most comprehensive model of the relevant reality) is worthwhile, it eases the tension among multiple interest groups and makes the decision-making less complex, costly, and subjective.

This is compared to the disparity of metrics (between project appraisal and subsequent evaluation) applied so far to measure and control project performances. The all-embracing NVA is the Alpha and Omega of VBM (Value Based Management); neither EVA® nor CVA®, but NVA. The before-tax means the tax rate is zero. The calculation itself, the scheme, is exactly the same in all respects; substitute T = 0, that is all. The idea of Weissenrieder (amongst many other writers), his matchless way of processing tax effects (re SSRN_ID501602) is a pure concoction.

Tax shields from debt exist by the grace of tax-deductible interest. Indeed, the qualification ‘tax-deductible’ itself is what matters and this qualification exists either fully, partly, or sometimes even not at all. In the case of debt and consequently interest, there still can be no tax effect. Modigliani and Miller (1958, 1963) studied the effect of leverage on the firm’s value, but their famous Proposition I, stating “in the absence of taxes, the firm’s value is independent of its debt (Fernandez, re SSRN_ID290727, p. 8)”, is abundantly not true. VTS, the values of a levered firm, and the range of WACCs (see footnote 4), which are proclaimed by various writers are not true. Their accounts are based on weak definitions that suffer from a lack of proof. For more re ‘Valuing Companies and VTS’ http://ssrn.com/abstract=550382.

Furthermore, what has been argued by so many people e.g. Pablo Fernandez about tax shields (VTS) is not true, re SSRN_ID290727. Tax is a fact of life. Without correctly dealing with tax effects, all values are ‘out-of-control’. Whoever is not aware of the real tax burden nor fully counts it, endangers the continued existence of the company. This is because the after-effects are self-evidently wrong decisions.

The ‘Go/No Go’ Decision Regarding Strategic Investments is the title of Appendix 10.2 from the book The Profit Formula® The Way to Easy Profit Measurement ISBN 9781086333992 available at Amazon. Appendix 10.2 is about what is said in this article and fully explains all of it in a completely worked out numerical example from start to finish.

Footnotes:

  • Preservation of Value, Jacobs, 1991, p. 39: Laws of nature hold true independent of time and place; first edition.
  • The second edition ISBN 9798637745296 is available on amazon.
  • Re ‘Capital Budgeting, NPV v. IRR Controversy’ http://ssrn.com/abstract=981382
  • Minimal Operating Surpluses i.e. The RED LINE.
  • Re ‘The One and Only Standard WACC’ http://ssrn.com/abstract=756105

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Jan Jacobs

Jan Jacobs

Independent Researcher Business Economics
Jan Jacobs, an independent researcher in the field of business economics and author of The Profit Formula®: The Way to Easy Profit Measurement. I have more than 20 years of experience as a lecturer in business economics in higher day education and also in evening education for adults at SWOT (Stichting Wetenschappelijke Opleidingen Twente).

As a subject teacher, I have always been critical of what was in many Business Economics textbooks. I am the author of The Profit Formula®: The Way to Easy Profit Measurement, Budgetary Control: Scientific Perfection Business Economics, and Banking World Finance Credit Crises: Tips, Facts and Editorials about what happened and what needs to be done.


Jan Jacobs is an opinion columnist for the CEOWORLD magazine. You can follow him on LinkedIn, Amazon, and JBAdatabank.