The past 8 posts have been part of a long series on the Value Creation formula. The last several were a painstaking breakdown of the Balance Sheet, all for the purpose of tracking Amount Invested. A fair question is Isn’t there an Easier Way to track Amount Invested?
A brief recap:
- Value Creation = Today’s Value less Amount Invested (simple formula)
- In the Owner’s Equity part of the Balance Sheet, Paid In Capital–Gross reflects the amount that has been invested in the enterprise from inception.
- Dividends is how much cash has been returned to equity holders
- Paid In Capital–Net is the difference between Paid In Capital–Gross and Dividend. It is one and the same as Amount Invested.
- Forecasting the Balance Sheet into the future is as important as forecasting Revenue, EBITDA, and Capital
The reason for using the Balance Sheet to track these numbers is because the Balance Sheet, well, needs to be balanced. That is, there are a lot of other accounts on the Balance Sheet that change each month–sometimes in a helpful way, and other times in a hurtful way. The changes in these accounts usually trace back to decisions that are made by the operators of the business. Or they relate to execution effectiveness (or ineffectiveness) of management. The Income Statement of the business–that is, Revenue, EBITDA, and Capital–materially influences the Balance Sheet. However, some Balance-Sheet-influencing management activities are not captured in the Income Statement. Many of these are related to Working Capital, a topic I will cover in a later post. Some are related to other items, such as Capitalized Leases.
The use of the Balance Sheet to track and forecast Amount Invested requires that management understand all variables that impact the Balance Sheet variables. But understanding is only step #1. Step #2 is when the dialogue shifts to
Our job is to create value. We have a way of measuring value creation: Value Creation = Today’s Value minus Amount Invested. We set financial goals around Value Creation. We measure how we are doing against these goals. We know how the actions we take when managing the business affect this calculation. We are constantly learning how to better manage the business in a way that maximizes Value Creation.
Recall my earlier quip: “you aren’t a P&L manager unless you manage a Balance Sheet“. Is it beginning to make more sense now?.
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