The More, the Better: The Fundamental Truth….

The More, the Better: The Fundamental Truth…. by Aparna Ghaisas

The life is all about meeting the expectations. In fact we are said to excel if we surpass the expected.

It’s about creating a benchmark, achieving it and then outperforming it.

A business unit is said to be worth, if it’s able to cover the resources consumed and harvest more and more, in comparison with the amount of the resources expended. Therefore the primitive benchmark of a business is expenses incurred and the business tries to go beyond and earn profits.  Higher the profits, more lucrative is the business.

But that is just not adequate. The business has to yield more returns with reference to the investment that has gone in (i.e. Return on Investment: ROI).

However, can we infer that the business is worth continuing if it records a nonzero positive return? The business is said to be earning sufficient returns only if the returns cover the cost of the money invested in the business. Hence cost of capital becomes the benchmark for expected ROI. The investment in the business is said to be meritorious only if it covers the cost of funds and gives more than that. The cost of capital covers both accounting cost and economic cost of funds i.e. interest on loan funds as well as normal returns expected on owner’s funds. The business is said to create value if the returns are covering and excelling the capital charge. (Economic Value Added: EVA)

The years together performing, efficient and ethical business will ultimately create excess in market. Market value of its capital stock would be higher than its book value and such business may be said to have created value in true sense. (Market Value Added: MVA).

Therefore ‘the more the better’ is the fundamental truth of finance as well.

 

 

 

 

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