Yes – driving for increases in business value is the principal deliverable for all business managers, no matter where they are in the organization. Managers are the agents of business owners, and in most companies, their role to manage for value is clear-cut.
What is the value of a business, anyway? While you wouldn’t pay anyone for a stream of cash that has already come to you in the past and is now in the bank, a future cash stream does have value. It’s the same with business; a business’ value rides on the prospect that it will deliver a stream of cash in the future. The greater the cash flow expectation, the greater the intrinsic value of the business. In fact, for most businesses, three-quarters of their intrinsic value is in the cash flow expected in the next fifteen to twenty years – and that’s an established mathematical phenomena.
So, of course, that is what business leaders should focus on; cash-based profits in the next fifteen to twenty years. Which brings us to the Holy Grail of business management; what must business leaders do to maximize cash flow in that period? It turns out that the answer is not difficult to see, and is even patently obvious to anyone that stares at a P&L statement for a while. The fact is that changes to top-line factors (which are external-facing – sales volumes and price) impact cash flow to a degree that far outstrips changes in all other factors (which turn out to be internally-oriented – such as controlling COGS and the like). In short, it means managing market moves, using “market strategy,” with the specific objective of maximizing long-term cash flow and value.
That means choosing which markets to focus on and what differentiation to adopt in each market based on what the cash flow prospects are; market targeting and differentiation are the two components of market strategy that drive sales and price. While this may sound rudimentary, it turns out that 20% to 40% of the capital invested by the average healthy Fortune 500 or mid-cap business serves markets that don’t even earn their cost of capital, and 10% to 20% actually drain cash.
This is why it is so important for business leaders to use reliable economic information – and the shortcomings of using the financial accounting system, discussed earlier, result in an enormous amount of destroyed value. Without reliable economic information negative-return market positions are allowed to remain, and in most cases business leaders continue to invest and grow them unabated, and increasing the destruction of value. Moreover, other areas in the business with high positive returns don’t receive growth investments they deserve, as investments are spread around evenly like butter.
Rectifying this can boost near-term cash flow by well over 10% - to say nothing of re-deploying some of that invested capital and re-directing growth investments to positive-return areas. Admittedly, it’s not always easy to clean such issues up, but the first step is in seeing the issue; which existing accounting systems simply don’t. Business leaders have to go though their markets – looking at segments like offerings, customers, channels and geographies – and create a picture of cash-based profitability at a granular level. Tough work, but easily worth it.
Dealing with the near-term is only the start, however. While it’s critical to get the business on a solid footing as early as possible, it is the long-term where the value game is really won and lost – knowing where the pools of profit will be in the next couple of decades. This means that business leaders have to spend time understanding the market’s future, and deciding how to invest the owner’s capital using their own vision of the future and forecasting where cash profits will be, rather than allowing serendipity to decide. That sort of proactive leadership means you actually have a chance of spotting and creating opportunities. In fact, it’s interesting to look at this issue in the reverse; given such a large proportion of business value is in the fifteen year timeframe, what are business leaders doing now to manage it? It could be seen as reckless not to develop thoughtful and fact-based view of long-range market Profit Pools.
Business leaders are alone in being responsible for doing this. Their job is unique. Even if the leader’s tenure at the top is just a few years, getting the business on a trajectory well beyond that tenure is critical to valuations. The more fact-based and rationally thought out are the long-range cash flow expectations, the more investors will bid up value; investors are already comfortable with the idea that value is driven by future cash flow expectations.
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