Leading a Value-Based Management Implementation

Leading a Value-Based Management Implementation

By Marwaan Karame

A value-based management (VBM) implementation creates an opportunity that can greatly enhance a CPA’s stature within an organization. By adding to the reporting and auditing function a role that is critically involved in the strategic direction of a company, a VBM implementation enables a CPA to become integrally involved in driving shareholder value.

A VBM implementation aligns the interests of management with the interest of shareholders within a public or private company. The process begins by applying the concept of economic profit, also known as economic value added (EVA), to the decisions and management practices of a business.

Economic profit is the calculation of a company’s net operating profit after taxes (NOPAT), minus a capital charge for the investment or capital employed in the business.

Take, for example, a hot dog vending business that requires an investment of $1,000 for a cart and inventory. This investment is funded by personal savings, such as from a mutual fund that yields 15 percent, and money borrowed from the bank. When considering the foregone return from the mutual fund and the interest on the money borrowed, the cost of this capital works out to a combined annual rate of 10 percent. Assuming at the end of the year the NOPAT is $150, the economic profit—calculated by subtracting the $100 capital charge (10 percent of the $1,000 investment) from the NOPAT—will be $50.

Economic profit explains that a company creates value by generating a return on investment that exceeds the cost of capital. Broadly defined, the cost of capital is the weighted average cost of borrowing money from debt holders and the expected return required by shareholders. It is the expected return required by shareholders that is missed on an income statement and often neglected when making management decisions.

CPAs often make great champions of a VBM implementation because they understand numbers and know about finance and accounting.

However, calculating and reporting the economic profit of a company does not constitute a VBM implementation. It should not be construed as an accounting or finance initiative, but as a change in culture in the employee’s and manager’s mindset to think, act and get paid like an owner. Consequently, a VBM implementation requires a project leader who can measure value creation through accounting and finance, and who has the capacity to change the corporate landscape.

A VBM project leader develops a broad and deep understanding of the operational and strategic elements of a business. As a project leader, a CPA would be required to conduct site visits and speak with employees at all levels of the organization. These site visits often provide a CPA with a better understanding of operations, discovering the factors that truly drive the numbers. The visits also provide a CPA with the opportunity to further develop an internal network of business associates, creating trusting relationships with other functional heads, which lead to increased responsibilities for the CPA. This makes CPAs more marketable, both internally and externally.

A CPA engaged in a VBM implementation also may find great satisfaction in having the organization adopt financial principles that create wealth and shareholder value. A frustration among many CPAs is observing nonfinancial managers from various business functions who make unprofitable decisions under the pretext that these decisions are “strategic,” often based on “gut instinct.” A VBM implementation creates a forum for CPAs to enhance the financial acumen of a corporation, and complement management’s “gut instinct” with sound financial principles. It is this accomplishment that can be a CPA’s greatest source of satisfaction, if not the greatest source of relief.

Marwaan Karame is managing director of IDG Capital Group, a financial advisory firm focusing on value-based management and mergers and acquisitions. He will teach an eight-hour course on value-based management this summer for FAE.