How Do We Determine the True Value of a Business?

The value of an enterprise can be interpreted in many ways. Traditionally, "enterprise value" represents the real MONETARY value of an organization after all debt and cash is taken into consideration. When compared to the market capitalization of a company (share price times the number of shares), enterprise value indicates the worth of an organization to interested investors and shareholders. Although there are a number of other measures of financial capital, enterprise value is seen as one of the most valuable. But is it misleading? Does it truly tell us the value of an organization? When you stop and think about it, the term “value” means something different to everyone.

Sure, shareholders and investors want to know what they are getting for their money. And this makes complete sense! In addition to various other indicators like EBITDA, P/E and sales, enterprise value is an accurate representation of a company’s monetary value. But does the enterprise value (calculated as market cap + total debt - cash and cash equivalents) give us the whole picture of what else is going on in a company? Could it be that enterprise value is similar to GDP which measures everything in terms of growth? In Nature, Journal of Science, Costanza et al. state, “If a business used GDP-style accounting, it would aim to maximize gross revenue – even at the expense of profitability, efficiency, sustainability or flexibility.”¹ By solely looking at financial indicators like enterprise value, it is possible that businesses are also overlooking natural resources that allow for the flow of critical raw materials, proper equipment or work/life balance for employees and positive culture development.

In my last post, I examined the five capitals model (natural, human, social, manufactured and financial capital). Most firms either have all these types of capital within their organization or interact with them very closely. Could human capital, the health, knowledge and skills of individual employees, be seen as value? What about the culture and community created within a company? Is there a way to measure this? The way an organization utilizes its natural capital is arguably the strongest indicator of longevity. As goods or services are produced, the volume of resources that provide raw materials are invariably affected. If the primary source of raw materials (the stock) is extracted beyond the rate of reproduction or replenishment, then the company will face certain demise. Surely, decision makers would want some way to measure their resource stocks. This is valuable to them, right? To put it in terms of enterprise value, an investor wouldn’t want to get involved with a company that carries tremendous debt in natural capital, an accumulation of employee complaints or poor relations with the surrounding community.

Perhaps a new calculation for enterprise value could be created. One that takes into account not only financial metrics, but natural, human and social capital as well. One possible solution could be the expanded enterprise value calculation below, which includes all types of capital.

Enterprise Value = Financial Solvency + Liquidity + Resource Ratio (Use/Stock) + Employee Happiness + Community Involvement

Source:

1) Costanza, R. 15 January 2014. Development: Time to Leave GDP Behind. Nature.com. Retrieved on 26 April, 2014 from www.nature.com/news/development-time-to-leave-gdp-behind-1.14499

Five Capitals Framework - An Appropriate Guide for Business?

The Five Capitals model provides a strong platform for sustainability, but is not enough on its own. While there are many alternative names for the five capitals, (physical capital, knowledge capital, intellectual capital, spiritual capital, organizational capital, etc.) it seems the main point of this framework is to encourage decision-makers to pursue a much more balanced approach to business. I think this is an intelligent approach that can help businesses look through the sustainability lens and learn new ways to create value, but I also think the creator of this framework, Forum for the Future, could do more to allow the idea to be effectively utilized by business. However, perhaps the simplicity of the framework permits a degree of freedom for the user making it more useful to a larger crowd in the end.

In the context of business and the economy, these five capitals: natural, human, social, manufactured and financial, have the potential to make waves in any community. My initial impression upon reading the Five Capitals Model document (https://forumforthefuture.org/sites/default/files/project/downloads/five-capitals-model.pdf) was that it is pretty obvious THIS is what business needs to be doing to survive and make a positive impact. It all comes down to striking a balance, just as we humans need to eat a balanced diet, exercise, sleep sufficiently, and socialize with family and friends among other things. A few questions that arose in my mind were:

-       How can a company define for itself which capital it should capitalize on (save financial) while still keeping the others in tune?

-       Is it possible for a business to survive on just enough and fulfill its purpose, or is it written into the mission of every business to maximize on all fronts?

To run an organization as a machine as if all it depended on were inputs and outputs and to seek one goal, profit, is completely shortsighted. To make this even clearer, businesses exist because of humans, are run by humans, and interact with everything that is living either directly or indirectly. So, the five capitals model is a step in the right direction for business and the economy, but there is so much more to be accounted for than just what falls into these five categories.

Natural capital sustains all other types of capital, but I believe it is also part of all other types of capital as well, most notably human and social capital. This means businesses would do well to focus MUCH more on their interactions with nature because it directly affects their long-term survival and the good of the economy. Furthermore, the enhanced relationship with nature would serve as a compass for strategy and major decisions. For example, as seasons change and nature provides varying levels of resources, businesses would be more adept at predicting where to utilize assets and how to reduce costs. Educating employees on how a company relates with the natural environment would create a pool of ideas for business practice improvement and generate a healthier workforce.