The MfVA model includes only topics relevant to discuss for management. Attention is not diverted to discussions about non-value-creating accounting issues. The model is simple and tightly linked to the ongoing operations and, therefore, it can be used by managers for understanding and communicating business realities. It is simple because it measures only cash flow and has the focused purpose to show whether strategic investments are profitable or not. Its purpose is to guide managers in everyday business decisions. The MfVA model can cause companies to reassess not only the profitability of products and customers but of entire businesses.
A fundamental difference between traditional accounting and the MfVA method is that the MfVA method holds managers responsible for the evaluation of the MfVA information. The index in a specific year could be compared with temperature. The measurement itself is fixed and not relative to changing conditions.
It could be argued that most investments should be most profitable in the earlier part of their economic lives. The MfVA index will help managers to understand this business logic since it in real terms represents a fixed benchmark. Most strategic investments will have a MfVA index higher than 1.0 when they are most competitive. Over time the MfVA index is likely to decrease, and when the assets economic life is nearly over, the cash-generating capacity is likely to be very low, resulting in a poor MfVA index.
A correctly focused value-based management concept has the organization focusing on the relevant issues. It will be based on the four factors that determine value: strategic investments, the operating cash flow they generate, the strategic investment's operating life, and their capital costs. With today's accounting, some relevant issues are discussed; any irrelevant issues are included while maybe some relevant are excluded because accounting is not focused on the four factors that determine value.
The specific results from using this model demonstrated that several manufacturing lines that were generating large profits were, in fact, not as valuable to the company as originally thought. The OCFD for these lines was proportionally higher than those of other lines, resulting in MfVA indexes approaching 1 while other smaller lines had indexes greater than 1.5. The immediate reaction was to analyze the various elements contributing to OCFD. Product pricing was also reviewed to determine if there were unique circumstances or anomalies in the business. While nothing was done immediately, all future manufacturing capital asset requisitions are now required to be reviewed using MfVA. Interestingly, all investments made in equipment are now also tracked against the approving documentation to see if investment value added is as originally planned.
CONSIDERATIONS AND FUTURE STRATEGY
The applications of value-added techniques such as CVA to business operations at almost any level are limitless. Virtually any process can be evaluated using some aspect of value. While most companies use these tools to understand companies, there is nothing stopping anyone from using the concepts at much lower levels with equal or better results. The primary difference is that at corporate levels, decisions using these concepts are strategic in nature and may require long periods of time to succeed. On the other hand, a line manager can use the same tool to make strategic and tactical decisions. The specific piece of equipment to be acquired can better be evaluated in light of its ability to add value over its economic life at a certain cost. These results can be seen almost immediately.
A number of major interest areas are likely candidates for value-added techniques. The question is only when will someone get around to them. One area of interest is the supply chain. In the foreseeable future, a model will be developed that uses very different criteria than is used today to evaluate suppliers, products, logistics, and costs. This will all be done with numbers and values that differ from the accounting standards used to date.
The concept will also be used to evaluate product platforms. Decisions concerning platform growth, diversification, and elimination will be much more quantitatively approachable. This also holds true for other areas such as R&D management and inventory management.
Regardless of new areas of application or other advanced uses, there are still only three ways to increase a company's value-added, and these three methods will be used as the basis for questioning all value-added analysis:
1. How can I earn more profit without using more capital?
2. How can I use less capital to create the same amount of profit?
3. What are alternative projects with high index numbers where I can make investments?