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
I would be curious how we might measure some of those alternative metrics. I believe it can be done, and has not yet been fleshed out. One way we might do this is through a self reporting scale for human happiness. This has become an accepted measure for pain in medical settings. One a scale of one to ten, how happy are you today? Longitudinal data creates the context to map trends over time.
ReplyDeleteThank you!
Stephen
Hi Kevin,
ReplyDeleteI wrote a post similar to yours and I agree, that certain capital (environmental and social) is overlooked when using the traditional enterprise value equation. IMHO, businesses consider resources, employee happiness and community involvement as subjective measures and typically, there isn’t room for subjectivity in business. I think that’s the very thing that business is lacking. There’s definitely a place for objectivity and cold hard numbers yet they need to balanced with the “human” element. I really like the “revised” equation as it takes in capital that is ignored using the current standards.
Enterprise Value = Financial Solvency + Liquidity + Resource Ratio (Use/Stock) + Employee Happiness + Community Involvement
-Hillary
Hi Kevin, Your post reminded me about the write-up we read recently about Facebook’s purchase of WhatsApp for $19 billion. $19B!!! A couple of years ago (2012, I think) they purchased Instragram for $1 billion. $1B!!! I would love to understand the valuation used to derive those estimates and negotiations, and what factors what into justifying such large purchase prices. That enterprise valuation must have been drawing on some serious assumptions of the brand value those two ventures would bring to the company.
ReplyDeleteHi Kevin,
ReplyDeleteThanks for your thoughtful post. i think you're right that what we look at when we determine value is really quite skewed. I often wonder how we got to this place collectively, because I would bet if you asked most people what they value they wouldn't say anything that even resembles the equation for determining enterprise value.
Your post made me think of Ray Anderson's equation for measuring impact:
I = P x A x T. Impact = Population x Affluence x Technology. (You probably remember from his TED talk that we watched, he changed this equation by dividing by technology) This is a fascinating thing to consider, but seems to be a better equation for measuring impact on a societal level.
I'd love to see a metric devised that could be posted on every business, a grading system measuring impact. B Lab's impact rating system is the best I've seen in this regard. The point is, we can't even sell bottled water without a nutrition label being legally required on the packaging so why shouldn't businesses come with a nutrition label of their own?!
Thanks for sharing your thoughts,
Maren
Kevin,
ReplyDeleteThank you for the post and for throwing out a potential alternative equation. Your passion for employee engagement and happiness is one that has come through in almost every blog of yours that I have read. I think it is an element that is to easily overlooked. Every CSR class that I took before BGI focused the human/social section on human right violations and fair working conditions. While these factors are vitally important in CSR, factors like employee engagement and empowerment are also essential parts of the conversation.
Thanks for reminding me of these factors.
Jeannie
Kevin,
ReplyDeleteThe reference to GDP and Gross Revenue for the measure of success for a business, epic! This was a "touche!" moment if you ask me.... I feel the very same way... value of a business is so much more that the one or two lines we give it in the financial worksheets and papers in which we typically list it. Thanks for sharing!