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Relative Strengths and Weaknesses of Financial Analysis Methodologies
Various authors from Value Analytix
1.1 Introduction
In finance a considerable amount of methodologies are used to analyse businesses
and to measure their performance. There is consensus in literature that value
creation is the single best measure of corporate performance; good performing
companies seem to create more value for all stakeholders than poorer performers.
There is, however less consensus about what methodology should be used to
measure value creation. The reality is that all of the methodologies that claim to be
useful for "value analysis" are not the same. In many cases the fundamental
assumptions underlying these methodologies are different. Consequently, these
various methods do not all produce the same answers or insights into a business'
performance or prospects
The focus of this article is a comparison of accounting measures, the Shareholder
Value approach described by Alfred Rappaport, the Economic Value Added (EVA™)
technique described by Stern Stewart and the Cash Flow Return on Investment
(CFROI) approach of the Boston Consulting Group. Information and research about
the efficacy of the different approaches are limited and is primarily provided by
authors with strong commercial interest in the outcome of any research into the
effectiveness of the methodologies. The aim of this article is to contribute to the
developing dialogue on the appropriateness of different financial analysis techniques
and performance measures. The view at Value Analytix is that it would be a mistake
to believe that any single measure or analytical technique is perfectly suited to all
types of financial decision support. Given that no technique can adequately fulfil all
roles, a chart is included at the end of this article in which the four different financial
analysis methodologies are rated by Value Analytix in terms of their strengths and
weaknesses.
2.1 Accounting Measures
Accounting measures were developed for reporting and controlling purposes - which
is still their main use today. Accounting measures provide much information on the
historical performance of a business, and they are often used to provide information
on which to make decisions about future strategies and plans. Examples of
accounting measures are profit, profit growth, return measures such as return on
equity, return on invested capital and return on investment, earnings per share,
market to book ratio and price earnings ratio. All of these and other accounting
measures can be found in standard accounting textbooks.
The main advantages of accounting measures are that they are easy to calculate, the
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data needed is readily available, and they are widely understood and thus easy to
communicate. Due to the ease of communication, accounting measures are often
used for reporting - both internally for management and externally with investors.
Accounting measures describe historical facts in much detail, and give some idea of
the historical performance and current status of the company.
However, one should be careful in how accounting measures are used, especially
when they may be used to guide management decision making or to give a view of
the future performance of the company. Accounting measures have several serious
flaws when used for performance measurement or planning. Firstly, accounting
measures are based on accounting figures, which are kept in order to comply with
statutory reporting requirements. Such numbers were not developed to be used for
performance measurement, and can also be reported quite differently, even within
one statutory framework. When attempting to compare accounting numbers
internationally, these problems become even more severe.
Accounting measures are also historically and short-term (i.e. single period) focused.
When used for performance measurement or planning, accounting measures fail to
take account for risk or the time value of money. Many account numbers primarily
focus on managing the income statement, placing low weight on the actual cash flows
which are in part driven from the balance sheet. Accounting measures such as
earnings (and related ratios such as price-earnings) have also been shown to be both
empirically and theoretically poorly correlated with the actual market value of
companies.
As an example I would like to mention a Merrill Lynch report*, called Goodwill
revisited. Their aim with this report is to spotlight inflated profit figures in The
Netherlands and thus spotlighting earnings based return measures.
Merrill Lynch restated balance sheets and income statements for all AEX and MidCap
index constituents and adjusted it more towards anglo-saksan accounting principles.
All goodwill related mutations were taken into account. The book value of the
goodwill was added to reserves, while depreciation costs were charged to the income
statement. Under the amortisation scenario, a straight line depreciation period of 20
years was assumed, starting the year after amortisation.
The conclusion of the research report for the 25 AEX constituents were that earnings
per share declined by 10.7%, the P/E ratio raised by 3.0 points to 23.1 and return on
capital employed declined by 4.0% to 13.4%.
Accounting measures will always need to be used for external reporting and statutory
and budgetary control purposes. They were not designed for use in valuing
companies or driving strategic plans, and they are not suitable for these purposes.
* Note:Merrill Lynch, Goodwill Revisited, Global securities Research & Economics
Group, Global Fundemental Equity Research Department 30 October 1997.
3.1 Shareholder Value Analysis
The Shareholder Value Analysis (SVA) links strategies directly to cash flow and value
creation. Using SVA involves management expertise, strategic planning frameworks
such as Michael Porter's value chain, and so called value drivers to translate
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strategies into forecasted cash flows. The drivers include:
Sales
Sales growth
Operating profit margin
Tax rate
Incremental working capital investment
Fixed capital investment
The cost of capital
Value growth duration
The Shareholder Value approach incorporates both systematic and specific risk into
its analysis. Systematic risk is included through the cost of equity in the weighted
average cost of capital (WACC) using any of a number of methods depending on the
situation at hand. These methods include CAPM, APT, which can be calculated using
peer group analysis, cross sectional analysis and others. The cost of equity is
relevered using the Hamada algorithm whenever future financial leverage (gearing) is
anticipated to differ from past levels. Specific risks are explicitly incorporated into the
cash flows using scenario analysis.
The last value driver, value growth duration, corresponds to the length of time that
the firm is expected to create value (i.e. earn returns above its cost of capital). It
varies from less than three years for companies whose strategies are quickly
emulated (e.g. high technology firms) to over 20 years for companies which
strategies take a long time to reproduce (e.g. natural resource companies).
The shareholder value approach calculates corporate value as follows:
Forecasted cash flows are calculated for a length of time corresponding to the
value growth duration.
The operational cash flows are discounted by the cost of capital to determine what
is called the "value created during the forecast period".
To the "value created during the forecast period" the present value of the firm at
the end of the forecast period is added. This is known as the "residual value". The
market value of non-operating assets is then added to the market value of operating
assets to get the corporate value of a company. The residual value often comprises
50% or more of total corporate value and is determined using different approaches in
different situations. Perhaps the most common method of calculating residual value is
to take a perpetuity of the net operating cash flow before investment in the final
forecast method (normalized for non-current events). Other approaches include
"perpetuity with growth" (used in very rare situations when the creation of value is
anticipated to continue indefinitely) and "break up" value (used when the firm ceases
operations at the end of the forecast period).
The corporate value can be transformed to shareholder value by subtracting the
market value of debt and other obligations.
The shareholder value approach has gained popularity mainly because of the
following reasons:
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The approach uses complete information. It incorporates historical, current and
forecast information in determining the amount and timing of future cash flows, the
value growth duration and systematic and specific risk in its analysis.
The SVA methodology concentrates on the residual claimants of the company. By
choosing the strategies which create the highest value for the shareholders, the
management also creates the highest value for other stakeholders like employees,
other investors in the company and customers.
In the literature many surveys state the high correlation between cash outflow,
downside stock price movements and decreasing shareholder value. From this
research and experience, the discounted cash flow approach to understand investor
expectations has established its position as a pre-eminent, but not exclusive,
analytical tool for value based management.
3.2 Comments on SVA
Common comments on the SVA approach are the subjectivity, the high sensitivity of
the residual value to the cash flow, that this approach relies on CAPM as a measure of
determining the discount rate and that the approach has shortcomings in the area of
compensation and to some degree the establishment of micro performance
measurement systems within small business units or for specific business functions.
Subjectivity
It is correct to say that the SVA approach is subjective. The SVA approach preferably
involves specific forecasts about operating factors into the future. Because it
incorporates managerial judgement and strategic thinking, subjectivity is also
necessarily added.
However, certain other approaches, like ratio-analysis and the BCG's CFROI, avoid
this subjectivity only at the cost of relying on historical data and applying restrictive
assumptions about the future. Also, different assumptions can be tested in an SVA
model, showing the impact on value and revealing inconsistencies.
Sensitivity of the residual value
Residual value is highly sensitive to the cash flow in the last forecast period and the
rate of growth in perpetuity. To adress the cash flow concern, the SVA approach
excludes non-recurrent events and normalizes the cash flow used as the basis for
residual value.
Value Analytix argue that residual value should be highly sensitive to the growth in
perpetuity assumption. A firm that can create value indefinitely into the future (i.e.
one with a perpetuity growth greater than zero) should be much more valuable than
one that does not. It should be stressed that the perpetuity with growth assumption
for residual value is only applicable to the very few firms that have an economic
advantage that cannot be reduced by competition.
Reliance on CAPM
The SVA approach does not solely rely on CAPM as a mean of determining the
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discount rate. The SVA methodology can incorporate any method of estimating
systematic risk, be it CAPM, APT or any other approach.
Shortcomings in the area of compensation
Compared to the EVA™, the SVA approach poses the most important question in
performance measurement less directly. That question is whether a company earns a
better return on its investment than its cost of capital. A direct result of asking this
question is that the focus is on returns higher than the cost of capital, even if that
return is decreasing. Also EVA™ focuses more directly on the period shareholder
value is created instead of when the actual operational cash flow (free cash flow)
starts rolling in. However, since the focus of SVA is future performance, it is difficult
to apply when measuring historic performance. The EVA™ technique will be discussed
in more detail in the following section.
4.1 Economic Value Added (EVA™)
Value based management (VBM) techniques including shareholder value analysis
(SVA) and Economic Value Added (EVA™) are intended to be useful in helping to
choose, monitor and reinforce business strategies which will in turn increase total
shareholder returns (TSRs).
Stern Stewart & Co., the management consultancy company which accredited with its
popularization, describe EVA™ as "a simple financial measure of performance".
Perhaps more accurately, EVA™ is a performance measure which is easily
conceptualized, but often more difficult to apply effectively in practice.
Conceptually, EVA™ is the residual income which remains after operating income has
been reduced by an additional charge designed to capture the dollar value return
investors can be expected to require, given the amount of capital they have tied up in
the business.
In its basic form, EVA™ can be easily calculated as follows:
1. Take sales and deduct operating expenses and taxes. The result is termed NOPAT,
or Net Operating Profit After Taxes.
2. Estimate the capital charge as total capital (i.e. debt plus equity in a simple case)
times the cost of capital.
3. Subtract the capital charge from NOPAT and what remains is EVA™.
The method described above is termed the Capital Charge Method, and can be
rewritten to provide practitioners an alternative method of calculating EVA™. The
second approach is referred to as the Spread Method and the corresponding formula
is:
EVA™ = Total Capital * (NOPAT/Total Capital - Cost of Capital)
Where:
NOPAT/ Total Capital is referred to as the Return on Capital Employed. Both ways of
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calculating EVA™ are arguably easy to understand. The difficulty in application,
however, is in estimating the main EVA™ drivers - NOPAT, Total Capital and the Cost
of Capital - especially since over 150 possible adjustments to these drivers have been
estimated. The process of deciding which adjustments to make, and how to make
them, is what makes EVA™ more difficult (and subjective) when applied in practice.
The first stage in an EVA™ analysis is to adjust the NOPAT and Capital as reported in
an accounting framework so that they can reflect more accurately true economic
values. This is what Stern Stewart & Co. refer to as "grossing up the accounting book
value into an economic book value".
The adjustments are of two types: those items we intend on capitalising and the cash
we would have paid/ received if not for our debt/financing strategy. Common
adjustments to NOPAT include:
Any goodwill amortised needs to be added back.
The increase in any deferred tax reserve is added to NOPAT (or subtracted from
cash taxes).
Any increase in a LIFO reserve is added.
Since EVA™ separates financing (Debt & Equity) from operations the tax provision
figure reported on the income statement should be adjusted so that it reflects the tax
that would have been paid had we not paid less tax due to debt (this is known as the
interest tax shield).
Those expenses we have removed from the income statement should now be
capitalised. Capital is adjusted as follows:
Add cumulative amortised Goodwill and the accumulated Goodwill written of
directly to reserves.
Add the deferred tax reserve.
Add any LIFO reserve.
Finally subtract revaluation reserve.
There are of course many more adjustments that can be made either to reflect an
item that should be capitalised rather than expensed, or to establish a common
framework across accounting regimes. EVA™ analysis requires its practitioners to
make judgements about the definition of NOPAT and Capital Employed in a business
and these adjustments, not unlike many accounting adjustments, may be the product
of negotiations and judgements rather than rules or regulations.
4.2 Comments on EVA™
Proponents of EVA™ argue that valuation using EVA™ and SVA produce the same
results. Proponents further argue that since EVA™ can be used for performance
measurement and compensation, for which SVA is less suited, it should be used for
strategic planning and valuation analysis rather than SVA. If EVA™ and DCF produce
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identical valuation results, why complicate things by using two systems when EVA™
can replace SVA for valuation and strategic planning?
Unfortunately the above argument has three flaws:
Firstly, the equivalence with SVA for valuation purposes can be mathematically
correct but not necessarily helpful in providing a profile of cash flows on which to
base a company's funding requirements, nor in understanding the short term versus
the long term risks in a particular investment or valuation decision. The mathematical
equivalence is achieved because the EVA™ formula is a modified version of a
standard DCF formula within a mathematical construct in which all of the adjustments
in the EVA™ formula to the DCF results must net to zero. The result of this construct
is that it does not matter what beginning capital base is used in an EVA™ valuationthe resulting value will always be identical.
Secondly, in EVA™ the value of the starting capital base (one of the most subjective
components of EVA™, since you could have adjustments over varying periods of
time) determines whether future EVAsTM are positive or negative and by how much.
This means that where there is a low capital base it is easy to generate large positive
EVAsTM even though standard DCF analysis can show clearly that the business is
locked into a value destroying strategy (i.e. returning less than its WACC). The
difference with SVA is quite straightforward in that sensitivities using EVA™ are
focused on a single period or historical analysis and therefore reflect annual changes
in performance. SVA and EVA™ value drivers will be very different from one another
and managers will undoubtedly reach very different conclusions when comparing a
set of EVA™ value drivers with a set of SVA value drivers.
Thirdly, the mathematical equivalence only holds true prior to any adjustments made
to the components of EVA™ (either NOPAT or Capital Base) over the course of a
forecast. If any such adjustments are made -which will normally be the case for
performance measurement purposes- the mathematical equivalence between DCF
and EVA™ valuation is lost.
The following tables illustrate the first two of the above problems - namely that the
capital base used in EVA™ valuation is both irrelevant in terms of impacting value,
and misleading in terms of analysing periodical EVA™. The tables are adapted from
those developed by CSFB in a document entitled "EVA™ Primer" (1996).
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Figure 1 illustrates a standard DCF analysis, whilst figure 2 illustrates the EVA™ being
generated using the net book value as the beginning capital number. As discussed
earlier, the total value produced is identical, but the EVA™ generated on a periodic
basis are completely contrary to the cash flows actually being generated during the
same periods.
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Figure 3 illustrates the EVA™ being generated assuming that the beginning capital
balance is equal to the worth of the company if it only returned its cost of capital (i.e.
no value creation since NOPAT = Beginning Capital * WACC = $3,700 * 10% = $370)
based on the NOPAT for year 0. This methodology reflects accurately the value
created. Note that the value remains the same as in figures 1 and 2, but that the
annual EVA™ figures are very different. This would have huge implications for both
strategic planning and compensation systems.
To prove that the capital base is truly irrelevant in calculating the total value using
EVA™, figure 4 uses the number of miles between London and New York as the
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beginning capital base. Again the final value is the same, but the annual EVA™
figures must be considered meaningless.
4.3 Additional Questions to Ask
Before making any managerial decisions or judgements on the basis of EVA™ we
would suggest that you would need to know the answers to the following questions
before condemning on operating unit or praising another one:
1. Are they all using the same accounting standard?
2. Are all transfer prices "netted out"?
3. Are there any tax driven accounting treatments that impact on these figures?
4. Are all of the EVA™ adjustments consistent across countries?
5. Do the numbers for each region reflect a steady state of each business unit?
6. Are they all reflecting local discount rates or a group rate in dollar terms?
7. Do these single period number tell me whether or not shareholder value has been
created?
8. Would you alter your capital allocation policies on the basis of these numbers?
9. Would you alter the companies portfolio or strategy on the basis of EVA™ figures?
The Boston Consulting Group CFROI Approach *
5.1 The Boston Consulting Group CFROI approach
The keystone in the BCG approach is Cash Flow Return on Investment (CFROI). It is
analogous to the internal rate of return (IRR), but the way they calculate the
"investment" terms and forecast cash flows is distinctive. The components of CFROI
are:
Current Dollar Annual Cash Flow: Last year's inflation adjusted cash flow.
Current Dollar Gross Investment: Inflation adjusted total assets minus non-debt
liabilities and intangibles.
Current Dollar Value of Non-Depreciating Assets: Inflation adjusted current assets
and land.
Asset life: Average depreciation term for all assets.
BCG calls the "investment" term in the CFROI calculation "Current Dollar Gross
Investment". This is calculated by converting historical cost financial statement data
into current costs. This is necessary because the BCG approach uses real cash flow
discounted by the real cost of capital (this is just as conceptually sound as
discounting nominal cash flows by the nominal cost of capital). It also involves many
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complex adjustments to financial data including goodwill and inventory.
Note: The comparison of CFROI and SVA was seveloped by Tom Nodine, formerly of
Booz Allen Hamilton, Australia.
The next component of CFROI to be calculated is Current Dollar Annual Cash Flow. To
estimate these future cash flow s, BCG employs the following steps:
1. It estimates the remaining useful life of depreciating assets using asset life.
2. It estimates the annual cash flow of the assets, which are expected to produce
through the end of their economic lives.
3. It allocates non-depreciating assets to depreciating assets on a pro-rata basis and
assumes that they are "recovered" (i.e. converted into cash) at the end of the
economic life of the depreciating asset.
BCG then calculates CFROI as the internal rate of return that equates the present
value of future cash flows with the estimate of the Current Dollar Value of Gross
Investment.
5.2 Comments on CFROI
Similar to Value Analytix, BCG assumes that a firm's rate of return (in this case
CFROI) will eventually be driven down to a competitive equilibrium. Unlike Value
Analytix, the BCG approach assumes that this process takes 40 years to complete in
all cases.
To calculate corporate value, BCG takes the Current Dollar Value of Gross Investment
and applies its CFROI to produce future cash flows over a term equal to the
depreciating life of the assets. When retired, depreciating assets are assumed to be
replaced according to a historical asset growth rate.
However, both the cash flows and asset growth rates decay exponentially from their
recent historical rates to country-wide averages over the 40 year horizon according to
what BCG calls the "Fade Rate". For example after 40 years, all Australian firms are
assumed to have CFROIs of 5.5% and Real Asset Growth Rates of 2%.
To discount the cash flows, the BCG approach utilizes one "market derived discount
rate" for all businesses in a country. In short, BCG uses the country average CFROI
and Asset Growth Rates to project "market cash flows" and uses the current value of
the market to backsolve for the discount rate. This rate is always adjusted for
investor's taxes and sometimes adjusted for financial leverage. The BCG approach
seems to ignore specific risk entirely.
Why are the SVA and the BCG models so different? The answer lies in their original
purposes. BCG's 1993 brochure mentions that the SVA approach was "developed
especially for corporate planning and related applications". This is in contrast to their
model which was, "designed as a tool to assist the institutional investor in picking
stocks".
For picking stocks, BCG needs a systematic means of sorting through the historical
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data of thousands of businesses to identify potentially undervalued companies. They
also need to be able to backtest the model to identify how well it did in the past.
Developing separate yearly cash flow estimates, cost of capital and forecast periods
for each company, would simply be too time consuming for their purpose.
Accordingly, they developed a series of assumptions (cash flow determined by a 40
year CFROI fading to country-wide averages, constant cost of capital, etc.) that would
allow them to avoid explicit forecasts and be able to backtest their model.
While these assumptions are useful in helping BCG to pick stocks, they make their
model less useful for corporate planning. Corporate planners are primarily interested
in one company, its business units and competitors. In this situation, producing
explicit forecasts that match proposed strategies becomes much more manageable
and appropriate.
Corporate planners want to understand how changes in strategy will affect their
company's value. If you have the average company with the average strategy and
the average investment strategy and the average level of systematic risk is not going
to change, then BCG's approach will model your firm effectively.
For any company that is not average on all these accounts, the BCG model will miss
the distinctions. For example, would a natural resources company really want to
"fade" to the same CFROI and the asset growth as a computer company? BCG's
model would have it that way despite the fact that the rates of return and investment
growth vary significantly from firm to firm and industry to industry.
The SVA approach is more appropriate for corporate planning because it includes
strategy-specific forecasts. These bring out the distinctions in alternative strategies
and allow corporate planners to measure their effect on a firm's value.
The strategic implications of the SVA model are also more clear and intuitive.
Strategies that will legitimately increase a firm's value through their net effect on
sales, profits, taxes, investments, the cost of capital and value growth duration
should be undertaken.
Because BCG's model was designed for picking stocks, its strategic implications are
less straight forward. If we follow the model to its strategic conclusion, we could
increase value arbitrarily by growing assets (any assets) as fast as possible. In fact,
the sooner we do it the better because our CFROI is likely to be downward sloping
over the next 40 years! Clearly, neither implication makes economic sense.
Applying BCG's assumptions to strategic planning levels the very distinctions we are
trying to bring out.
Several other aspects of their model that are suspect.
1. With respect to the CFROI calculation, how can it be reasonable to assume that a
firm's non-depreciating assets will be converted to cash under anything other than
liquidation scenario? This assumption seems unreasonable whenever the firm being
analysed is expected to be a "going concern".
2. How can a firm's cash flows be logically linked to specific assets? Unless all
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depreciating assets have the same life, this assignment process will affect the final
result of the CFROI calculation.
3. BCG provides no description of how the inflation adjustments are made in
determining Current Dollar Value of Gross Investment. Without knowing this process,
it is impossible to determine whether the adjustments result in a reasonable value for
the "investment" term in the BCG's CFROI calculation.
4. BCG's application of its approach to identify undervalued stocks seems to ignore
market expectations and assume that stock markets are not weak-form efficient (i.e.
abnormal returns can be earned by using historical information only).This contradicts
studies conducted around the world showing that weak form efficiency is satisfied. If
BCG had identified a method of successfully identifying undervalued companies, they
could make much more money using it as an investment strategy themselves that
they could by trying to sell it to others.
5. BCG's calculation of Current Dollar Gross Investment excludes Goodwill which
often has economic value.
6. BCG's calculation of Asset Life corresponds to accounting depreciation, not
economic depreciation. ASSET LIFE = GROSS PROPERTY, PLANT AND
EQUIPMENT/DEPRECIATION = AVERAGE DEPRECIATION PERIOD
7. One of the statistics used to support the BCG model is flawed. BCG's primary
"proof" that their model applies in Australia is an analysis showing an R-Squared
statistic of 40% when "Value/Cost is plotted against CFROI minus Discount Rate".
Since BCG defines "Cost" and "Investment" as Current Asset Value, both sides of the
regression equation contain the factor "1/Current Asset Value". In this situation you
would be surprised if there were not a significant R-Squared statistic. For a discussion
of this error, see Eynon, Philip J. and Nodine, Thomas H., "Seven Critical Success
Factors for Value Creating Acquisitions" M&A Europe, March/April 1991, p.5.
4.3 Additional questions to ask
1. In the BCG materials reviewed, the Fade Rate changed from 5% to 20%:
How is the Fade Rate Determined?
What is the basis for the change?
How can we be confident that it is right now?
On what basis does it vary from firm to firm?
2. How is specific risk incorporated into the BCG model?
3. Why did they not choose to use the standard Hamada algorithm to adjust their
country-wide cost of capital for financial risk?
4. How are historical cost financial statement data converted into a current cost basis
for use in the CFROI calculation?
5. What are the results of backtesting BCG's model?
5.4 Why managers are better off with the SVA approach
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With a basic understanding of the models, we can now get back to the reasons that
our clients are better served by the SVA model.
1. The SVA approach is better suited to corporate planning:
As mentioned earlier, the SVA approach was, "developed especially for corporate
planning and related applications," while the BCG approach was "designed as a tool
to assist the institutional investor in picking stocks".
This difference in focus has lead to BCG to employ assumptions that ignore important
distinctions between corporate strategies and make their model less appropriate for
corporate planning.
2. The SVA model is more explainable:
SVA uses terminology that is much more comprehensible to operating managers.
There are no problems talking about sales growth, profit margins, and investment
with operating managers. Even without an accounting / financial background,
managers understand the major factors of the model. This may at first appear to be a
small issue, but it becomes critically important when describing and implementing
new strategies.
The BCG approach is not nearly so intuitive. It would be difficult to explain CFROI to
the average operating manager, much less his or her specific role in making it
happen.
3. BCG's model may not be suited for application to non-US firms, or natural
resources companies.
In the US, BCG says that their model achieves an "acceptable" tracking for 80% of
the Value Line 1,400 Industrials. Stated differently, they believe that their model
does not track acceptably for 20% of the largest firms in the US. Even if their model
was fully applicable to a market how can we be sure that a given client is not one of
the 20% to which the model does not apply?
BCG has had problems with their model in Australia. This is primarily because
Australian accounting standards allow more freedom to restate asset values than the
US GAAP allow. This problem is exacerbated in natural resource companies where
many of their assets don't "hit" the balance sheet in the US until they are unearthed,
but are often "written up" in Australia. BCG openly admits that the application of their
model to natural resources companies is, "still in the embryonic stage". Their 1993
brochure states, "it may well prove that the unusual characteristics of the resource
sector may best be handled by a traditional DCF model".
6.1 Summary
Our conclusion is that although EVA™ is a valuable contribution to compensation
systems, it remains a less attractive methodology for Value Based Management
where the objectives is to reduce the single year focus that budgeting systems inflict
on operating businesses.
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The race between SVA and BCG for the best corporate planning model is not even
close. BCG assumes away the very distinctions that are important in identifying
optimal strategies.
In conclusion, it should be stressed that there is no panacea in terms of
methodologies -different methodologies have different strengths and weaknesses.
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