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2.1 How to measure financial value based on income

Accounting is needed in order to assess the creation of value of the company through its result. Thanks to the income statement, you can explain the creation or the destruction of value of the company during the year, by comparing products and expenses of the company.

So, the income statement reflects the economic activity of the company and can be classified in:

• Expenses, i.e, definitive employment or consumption.
• Products, i.e., definitive resources or revenues.

The income statement includes expenses and revenues according to three main headings:

1. Business concern: elements of normal or usual business activity (raw material purchases, sales of finished products);
2. Financial: items related to financial transactions, i.e. bank transactions (interest paid on borrowing) or financial investments (paid interest);
3. Exceptional: elements of unusual nature, i.e. out of the current business activity (penalties or fiscal fines, sale of a machine.)

Among the products is the turnover, corresponding to all sales made during a period: it is the main income of a company.

The final difference between the income and expenses represents the amount of the result achieved by the company during its accounting year. This amount usually corresponds to one year.

To get the result of the financial year, you must subtract total expenses from total revenues.

Whenever the products exceed the charges, the company gets richer and makes a profit. You get a credit result written down in the charges heading.

Whenever the charges exceed the products, the company is impoverished and realizes a loss. You get a debtor income written down in the products heading.

2.2 How to measure financial value based on property

Accounting is also needed in order to measure the value creation of the company through its heritage. At one point, a balance sheet is build, taking into account the assets and liabilities of the company. Assets are recorded as identifiable assets with a positive economic value for the company, and on the liabilities are described the resources that enabled the company to own assets listed as assets.

On the balance sheet, items are united together according to two main headings:
To the assets:

1. Immobilized assets: elements sustainably held by the company (more than one year) to carry out its activity. They will be found over several successive years.
2. Current assets: elements held by the company, not intended to stay there for long (less than one year), i.e. less than one business cycle.

In the liabilities:

1. Own capital: composed of capital (contribution of partners or shareholders), of stock (cumulative undistributed prior results), and of the result of the fiscal year.
2. Company debts: these are debts with banks, providers, State, etc.

Thus, this is what you can find in the balance sheet:

• Assets in order of increasing liquidity (from the position with the less liquidity to the one with the more liquidity): asset at more than one year (immobilized asset) and asset at less than one year (current asset). The liquidity of an asset can be determined by its ability to be quickly converted into currency;
• Liabilities in order of increasing due (from the lowest to the most exigible position): own capital (capital is not intended to be returned to shareholders) and debts (loans will have to be paid but over a longer period than the debts of the suppliers.) The degree of repayment of a debt is related to the time available to the company before having to repay this debt.

With the balance sheet, it is possible to calculate the net book value:
To get the net book value, you must subtract total debts from total assets.
The net book value corresponds to the financial or heritage value of the company: it is the share of the assets of a business owned by the partners or shareholders.

Thus can companies seek an increase in their net book value, i.e., financial value, in order to 
satisfy the capital contributors. On the other hand, public organizations and associations do not seek any increase in their financial value, since they do not have to please capital providers.

2.3 How is it possible for organization management to contribute to the creation of different forms of value?

The following abilities and notions are needed:

Abilities:

• Distinguish different types of value and relate them to the expectations of the persons taking part in the process;
• Use a balanced sheet and an income statement to identify the financial value produced by an organization (mainly a company)

Notions:

Financial value:

• Based on income (from the income statement)
• Based on property (from the financial balance sheet)

2.4 One example

The Ramond company is specialized in the marketing of lawnmowers. The accountant informs yoof his balance sheet at the 31/12/N (in thousands of euros.)

Balance Sheet of the Ramond company at the 31/12/N

The Ramond Company owns, at the 31/12/N, 
items held for the long term to carry out its activity (immobilized asset), with more amount than those meant to stay for less than one year (current assets), i.e., 8 376 000€ versus 3 276 000€.

Moreover, the Ramond Company, at the 31/12/N, has debts (liabilities), a total amount of 8 264 000€.

Eventually, the result of the fiscal year N for the Ramond Company corresponds to a profit of 578 000€: therefore, the company has created value during the fiscal year N, since the result of the company’s fiscal year is positive.

The net book value of the Ramond Company amounts to: 11 652 – 8 264 = 3 388 thousands of euros, i.e. 3 388 000€.

This corresponds to the financial or patrimonial value of the Ramond Company: it is the share of the assets belonging to partners or shareholders. It can be found when you look again at the amount of own capital.

2.5 One exercise

Context:

The Codiasse Voyages company is a limited liability company, in operation for 26 years. Located in Lorris (45260), its main activity is the business sector of regular road transport of passengers. Different types of services are offered by this company, such as excursions organization, travel on behalf of school and sports associations, or school transport. The company owns two active commercial establishments, and its workforce is 17 employees. The company is managed by Mr. Frédéric Codiasse.

According to you, how is it possible for the manager of the Codiasse Voyages, Mr. Frédéric Codiasse, to ensure that financial value is created by his company?

a) Financial value based on income

b) Financial value based on property