Value Based Management

Value Based Management (VBM) is a powerful tool that is used to understand and prioritise cash-flow enhancement opportunities within an organisation. A rigorous methodology is followed to understand the as-is status, where value is being ‘destroyed’ and where it can be ‘created’. VBM reviews offer a thorough understanding of an organisations unique financial opportunities.

Simple definition of VBM

Value Based Management looks at the long term risk-adjusted discounted cash flows. To clarify:

long term looking at the future effect of past, current and imminent decisions
risk-adjusted understanding the probability (frequency) of a successful outcome
discounted cash flows understanding the longer term financial effect (impact) of the decisions

The Key benefits of introducing a Value Based Management philosophy;

Elimination of waste, errors and duplication of effort across the organisation
Realise short and long term cash savings to fund other activities and services
Provide a prioritised agenda for the improvement of efficiency
Eliminate activities that add no value for stakeholders
Highlight “hidden” quality, delivery, satisfaction and cost failures
Realise measurable improvements in customer satisfaction and performance
Provide improved services for less cost
Create a culture where all staff are empowered to improve organisational Performance
Promote inter-functional working to address organisational opportunities
Time compression of improvements by the provision of prioritised recommendations
Ensure resources are deployed where they can add most value
Focus management to measure and manage the important things (KPIs)
Provide one agenda for the organisation to achieve its goals
Practical, rigorous methodology to change the way staff & management run the business
Make Continuous Improvement and efficiency achievement a way of life

Scope of a VBM review

A VBM review can be scoped out in much the same way as an internal audit or a Best Value review. The main options are to review;

the whole (complete) organisation - most cost effective and most connected
a section of the business - Central Services, Asset Management etc
a function or process - such as repairs, rents, ASB, HR etc
a business activity - Income streams, procurement, training etc
a specific activity - current arrears, Right To Buy etc Contact us for more information and case studies/references

Typical top level process steps

To truly understand your organisation, the following must be incorporated into a meaningful review;

the way you measure and manage yourselves
your business plan
your accounts and budgets
management and staff interviews
group-based process mapping sessions
comprehensive data analysis

When to choose a VBM review

VBM as a methodology is best used when;

deciding whether to insource or outsource activities
cost or cost-benefit is a big driver
financial optimisation of the business is desired
cash flow management and budget performance is critical
preparing for mergers and acquisitions
performing Business Process Reengineering (BPR)

More detail on Value Based Management

VBM is an approach to management where all business goals and decision making are linked to their impact upon shareholder (or stakeholder) Value. The Value of a business is determined by its generation of future discounted cash flows. Value is only created when companies invest capital at returns that exceed the cost of that capital.

Why do companies exist?

Value Based Management was originally based on the premise that companies exist for the primary purpose of increasing shareholder wealth by maximising the long-term growth of the share price. This view is controversial and managers must always ensure they balance the needs of all the stakeholders in the long term. However, maximising shareholder wealth is the best way - indeed, the only way - to effectively serve the long-term interests of all stakeholders. We often lose sight of the fact that we are probably all shareholders, either directly through share ownership or indirectly through participation in pension plans.

This mission for management to serve the shareholders has long been accepted and focusing on shareholder Value allows managers to take the actions necessary to ensure the company’s capital is put to its best use.

The principles carry across to the not-for-profit and public sectors where the aims are to deliver the best services for a competitive price and to ensure organisational security and long term growth.

However, the major problem for companies today is that they do not understand how to measure Value creation or make decisions that are consistent with this mission. That is to say that most companies are still in the dark about exactly how they’re supposed to go about actively managing for shareholder Value in the short and long term.

Most business managers imagine they are employed to make money (or meet budget), however, there are so many other things that seem to be more attractive to them. Some of these may include; to make a fine product, to give a wonderful service or to become market leaders. Becoming the market leader in itself does not guarantee value creation for your shareholders.

The need to change and create Value

The first thing any company should do in pursuit of higher shareholder returns is to abandon the cult of earnings per share and the underlying accounting profits. Companies are putting themselves through needless pain to manipulate earnings.

“Many executives believe that if they can find a way to boost earnings, their share price will go up even if it is not matched by any underlying economic change. In other words, the executives think they are smart and the stock market isn’t. The market is smart, unlike the executive primarily caught up in the earnings-per-share mystique”

The presumption that companies can manipulate their stock prices by manufacturing earnings numbers is misleading at best, and leads to dishonesty at worst. Traditionally, accounting based measures such as earnings per share have been seen as the bible in assessing Value creation. The idea being that if a company delivers growth in earnings per share, then Value is automatically being created. This is often not the case and there has been a growing shift in focus from earnings per share to shareholder Value across corporate America in recent years. Considerable research has been conducted on examining the behaviour of stock prices when earnings and cash flow diverge, long term cash flows win every time. The conclusion is that cash flows and not earnings drive the stock market as the market sees beyond reported accounting data and looks to the cash impact of earnings announcements. For many managers and investors the easiest and most familiar measure – profit – has long lost relevance because it is easily manipulated and backward looking.

We are not just talking about a debate on how we measure performance. The way a company measures value determines how it is run. Companies such as Disney and Coca-Cola are managed formally to create shareholder value whereas other companies unknowingly have different agendas.

What is Value Based Management (VBM)?

VBM is not another form of downsizing, nor a financial version of re-engineering. Nor is it a fad. VBM is a fundamental way of measuring, managing and linking together all aspects of corporate performance that has roots as old as capitalism itself. It simply tells managers to do those things that they may already instinctively know are the right things to do, but that so often are obscured or prevented by traditional accounting-based measures of performance.

VBM is a process for linking business goals and managerial decisions to their impact upon shareholder value through the identification and management of a minimum number of Key Performance Indicators.