A shareholder of a company owns at least one share of a company. In other words, he or she is an owner of that company. A company has many assets, tangible or intangible and the shareholder has invested in those assets or has paid the money with which those assets have been bought. There has to be some rationale as to why an investor would choose one particular company to turn shareholder with. The rationale is that particular company’s ability to generate a hefty return on investment .
In other words, the objective of the shareholder is to make money for him or herself through profitable operations of the company. When the company profits, it enhances shareholder value, because the net worth or the shareholder equity of the company has gone up. There are any number of way through which shareholder value may be enhanced. Cutting costs to enhance shareholder value One option open to the financial manager is through cutting costs. Minimization of operating costs is something every financial manager dreams about.
There are many ways open to the financial manager to minimize costs. If the company in question is an automaker for example, then the less manpower the company invests in, the less costs will the company incur at the end of the month. In this respect, automation is the way to go. Automation will cut costs in more ways than one. Automation means less manpower, and as has been mentioned already, less manpower means less salaries and wages and therefore the financial manager, by investing in automation and divesting of manpower, will cut costs substantially.
But how does cutting costs enhance shareholder value? Cutting costs enhances shareholder value by increasing the amount of net profit which can go to enhancing net worth of the company. As a result, shareholder equity of the company will have gone up and with it, the shareholder equity ratio will have gone up too. Financial manager also cut costs by stream-lining the production process. In the automaker example, the production department will be looking for suppliers for the different parts which are required in the manufacturing of the vehicle.
What the financial manager should do is to develop an understanding of the raw materials market in the auto industry and set a limit for the production manager that he or she should never incur more than this much at the end of the month in sourcing raw materials. So the production manager will have exhaustively searched the market for low-cost suppliers of raw materials and sign the partnership contract with only that supplier which offers the lowest prices. In this way, the financial manager will have cut costs one again to the effect that the shareholder value will be enhanced.
Enhancing revenues to enhance shareholder value Cutting costs however is not the only option open to the financial manager. Enhancing revenues will also have enhanced shareholder value. Revenues are the starting point of the income statement of a company and therefore their ability to affect shareholder value is beyond question. Revenues are subject to the business environment in which the company is operating. If the economy is doing well and individuals and corporations are investing everywhere, then the revenues of the company will go up.
This is not to say that it is impossible for the financial manager to tinker with the company machinery here and there to maximize revenues. It is true that when the economy is down, there will not be many buyers willing to buy cars for example so that the financial manager at an automaker will have to live with lower revenues. However even then there are techniques which the financial manager can employ to increase revenues and in the process enhance shareholder value. When the economy is down, individuals and corporations will be unwilling to invest in cars.
This will bring down revenues and decrease shareholder value. What does the financial manager do in such a situation? What he or she can do is not to put all the eggs in one basket. If the only business the company is in has to do with manufacturing cars, then it will be ruthlessly victimized by the business cycles. In other words there will be little the financial manager will be able to do to counter the adverse effects of the business cycle. On the other hand, if the company invests in a wide range of portfolios, then the company will not be in such a hopeless situation.
So far we have been using a hypothetical automaker to illustrate the process of enhancing shareholder value. We have seen how the phenomenon of the business cycle makes it a bad idea for the automaker to invest only in autos. That is why automakers have been known to invest in a wide range of services such as financial services. This is to cushion the destructive effect of the business cycle when it is experiencing a downturn. Many automakers have been known to offer automotive financial services in order to make it easier for their clients to manage car-purchase financing during difficult times.
Additional services like this that automakers provide help to maintain the same level of revenues or even to enhance the level of revenues during difficult times. Enhancing productivity and product quality Another means of enhancing shareholder value is by enhancing productivity. The way to enhance productivity is to enhance efficiency. Efficiency can be enhanced by means of overhead reduction. For example, the financial manager can put forward a recommendation for commissioning research for ways of waste reduction. Waste disposal is a major headache for all businesses and particularly for automakers.
So the less waste that the production processes generation, the more cost-effective will the business be and the more productivity will it generate. A popular means of enhancing productivity at automakers is to adopt enterprise resource planning. An ERP package links all the departments of a company by means of an electronic network. This is once again a concept of automation but this is however at a different level. The level of automation previously mentioned was concerned with speeding up the manufacturing process as well as to downsize the production crew to the maximum extent possible.
This was concerned with the use of robotic manufacturing machinery to manufacture cars for example. The automation given by the enterprise resource planning is concerned with making the availability of information timely and convenient. For the financial manager to be able to manage his or her finances most efficiently, he or she must know what department is responsible for what category of costs to what extent. The financial manager can accordingly single out that department which is incurring the highest level of costs and put forward recommendations to streamline the processes in that department so as to bring the costs down.
As a result, the financial manager can perform his or her services more efficiently and be more effective. In fact, IT solutions like enterprise resource planning benefit the financial manager both directly and indirectly. Inasmuch as it is the responsibility of the financial manager to make sure that every department in the company toes the line in incurring costs, it helps if every department knows what every other department is doing to a certain extent so that two processes do not overlap or do not repeat.
Availability of information at the click of a button means that each department can be efficient and that is certainly the best of all possible worlds for the financial manager. For example , if the sales department and the inventory management department are both linked online so that the sale executive can see what items are available on the inventory at a certain point in time, then the sales executive can immediately answer customer queries and can process sales orders immediately.
This enhances the productivity of the sales department which in turn means favorable operating costs from the sales department for the financial manager. Thus the use of IT solutions can enhance the productivity of an entire company, enhancing shareholder value in the process. The financial manager can also enhance shareholder value by enhancing product quality. Continuing the example of the automaker, cars can be made more fuel-efficient. This will increase their sales, increase company revenues and enhance shareholder value.
Reducing risk and turning green to enhance shareholder value Reducing risk is another popular technique of enhancing shareholder value. The financial manager can put forward a recommendation for commissioning market research that will identify which products are likely to enjoy greater demand in future time periods. Based on the findings of this research, the management can decide which products to manufacture. Manufacturing focus should depend on studies that point to the direction of the future. In this way, risk may be reduced.
Studies will take into account whether the economy during the time period which it is researching will be good or bad and having taken that into account, research which products the average consumer is going to continue to invest in under the changed circumstances. Without these predictive statistics, the company will probably be running the risk of manufacturing a product that no longer enjoys demand, thus deflating profits and taking shareholder value down with it. So reducing risk is something that the financial manager should pay great attention to.
Several methods open to the financial manager in enhancing shareholder value have been discussed so far. None of these methods will work however unless the company has a good reputation in the market. A good reputation will factor in strongly when it comes to influencing the consumer’s purchase decisions. Therefore, building that reputation is key. Companies in different industries undertake a variety of environmental and community projects to bring themselves closer to the consumer. Preserving the environment and enhancing the quality of life are missions that can create a positive image for the company.
Consumers will tend to buy products from that company which has an environment-friendly and community-friendly image. As a result profits for that company will go up and shareholder value along with it. Advantages of enhancing shareholder value The advantages of enhancing shareholder value cannot be over-emphasized. The company will not exist for long if it fails to enhance shareholder value consistently through time periods. The only reason the shareholders are putting money into the company is to make more money. That becomes possible only when shareholder value is enhanced.
Enhanced shareholder value means greater net worth. As a result, the company has more resources to invest, whether in cutting costs or generating greater revenues or increasing productivity or product quality or reducing risk or enhancing reputation. All of these things require significant resources investments and the greater the shareholder value that a company has, the greater will it have the ability to build a competitive edge for itself by making resource investments in managing costs and revenues. Disadvantages of enhancing shareholder value
According to the above, it’s not a question of enhancing shareholder value having advantages. Enhancing shareholder is key to survival itself for a business organization. However the drive to enhance shareholder value can create some disadvantages as well. One of these is the motive on the part of financial managers to play around with financial statement figures. For example, by manipulating balance sheet and income statement figures to make them look good, the financial manager can make unprofitable business operations seemingly enhance shareholder value.
Unethical operations like these were the reasons behind the downfall of Enron and the pursuit of enhancing shareholder value is responsible for it. How does enhancing shareholder value help financial managers The goals and objectives of enhancing shareholder value can help to focus the duties and responsibilities of the financial manager. Under the circumstances, the financial manager knows that the only thing that matters as far as his or her job security is concerned is to increase the net worth and thereby the shareholder value of the company.
This facilitates planning on the part of the financial manager. The financial manager performs his appointed functions in a way so that costs are cut or revenues are increased or product quality and productivity is enhanced or risk is reduced or a good reputation for the company is built. As long as he or she has performed successfully in one or other of these areas, company profits will continue to maintain an upward trend thus enhancing shareholder value.