Profit for the period and shareholder value

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According to at least some people, the goal of a capitalist enterprise is seen as maximizing the wealth of its owners, of course within legal, ethical, political limits and perhaps more.

The wealth of its owners can be measured in terms of earnings for the period, i.e. the maximum dividends paid and/or shareholder value, i.e. the market value of the shares of the company. Profit (the measured profit number) and shareholder value: are two different phenomena, each with their own merits.

Moreover, cash flow and profit are two different phenomena. No cash flow is able to compensate for what is wrong with the profit figure. What has been argued by so many people, eg Pablo Fernandez (re: SSRN_ID330540: the saying “profit is an opinion, money is a fact”) is not true. It’s the other way around. The profit for the period can be measured exactly by means of the profit formula®.

About what “cash flow” is, various authors hold different opinions. Profit is not so important according to some people, the most important, they say, is the creation of value for the shareholder. The two conceptions, “profit for the period” and “value for the shareholder”, are not contradictory points of view, but most of the time in direct line with each other. Shareholder value is based on cash flows related to selling prices and these cash flows do not tell the whole story.

The profit for the period is the realized capital gain; it is the surplus that there is at the end of a period in addition to what there was at the beginning. Shareholder value, the value of a company, is at any time the present value (PV value) of all future proceeds minus current borrowings and debts; it is the price people are willing to pay at some point for the whole enterprise, in view of promising future profits. Creating more shareholder value is indeed very important too, but it is something other than period profit.

The PV value will be constant over time, in a stable situation naturally, when the replacement will always take place exactly for the elements that have been used. The profits made – beyond a certain level – are not to be despised. Boring business, yes indeed. The cow does not grow but all the time gives a bucket full of milk.

The quote of a former banker: “good business is boring business”. Perhaps a fund for widows and orphans, but such a fund always has a prominent place on the official stock exchange listing. Speculators go in search of bulls and bears, those companies whose PV values ​​move rapidly. Imagine, a fast growing calf, no milk yet, promises only for now. Something from such a growing cow in a calf company may become a loss or go to waste, but that same something can be replaced immediately (at actual replacement cost) and henceforth no one will see the difference.

The value of the equipment that has been replaced, the value of that asset, part of the total balance is not based on the PV value. The total balance can be based on each valuation basis, but normally not on the PV value. The PV value in this whole story is not in play at any time. Birds in the bush. Not yet in hand. The principle of realization, provided with a correct interpretation, defines what profit is. Profit is like milk. There is milk after milking; the milking stool seems to have three legs: people, planet and profit. Before milking, there are waits, promises, changes in PV values, whatever, but no milk. Profit is an ex post entity. Ex ante, profit projections and forecasts can be given. Profit can only be measured ex post, however. Ex post, retrospectively, we can of course calculate a difference of two shareholder values ​​at the beginning and at the end of a period considered. An increase is often better than a decrease. What is the significance of the difference in a specific situation?

The business may become minor, still profitable. The shareholder value (economic value: what could happen, in addition to the existing activities?) as well as the total balance (intrinsic value: what is actually present?) are snapshots, it is i.e. parameters having a value at a given time, while profit is a period parameter. Profit for the period and shareholder value are separate, but related to each other. They are linked together, strengthening or weakening each other and vice versa, but it is a loose relationship. One cannot take the place of the other. It is possible, by investing (additionally) to maintain the same level or to increase the PV (shareholder value), after which a (more) profitable company survives. The PV value is based on the cash flows linked to the selling prices and these cash flows do not tell the whole story.

Between cash flow and profit there is always something and that something can be a lot. Higher () cash flow may very well go hand in hand with lower (higher) profits. Increasing PV value can be accomplished by investing better. Higher PV values ​​and higher profits usually go hand in hand. An increase in PV value involves promises, expectations. Proving them, accomplishing them is another matter. Future profits will prove it. In the other direction, bad investments, lower PV values ​​and the future looks bleak. By measuring the profits of the next period as accurately as possible after the investments made, one can have the company at hand. Triggering of the whole operation. At the slightest little indicator, one can give proper indications of the necessary adjustment required. By not knowing the actual profit for the period, you lose control.

For more than noted in this article, re my free downloadable “Period Profit, Shareholder Value, Share Capital, EVA®, CVA®, NVA and Cash Flow – Different notions, each with their own peculiarities” http://ssrn .com/abstract=394140


Written by Jan Jacobs.
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