| Summary: | M.Com. (Financial Management) === The idea that strategies should be judged by the economic value which is created in terms of them is well accepted in the business community. Based on surveys of practice there is, however, great uncertainty regarding the way in which strategies and subsequent company performance should be evaluated. The best measure of corporate success is therefore a vexed issue. Accounting numbers and ratios are generally perceived to be poor measures of changes in economic value. The problem can be said not to lie with accounting, but in its inappropriate use. Accounting measures are constrained by accrual accounting conventions and financial reporting objectives; they are not designed to measure changes in a finn's economic value. Some of the limitations are the fact that earnings can be computed in different ways (depending on management's choice of accounting policy), earnings do not reflect differences in risk and it ignores working capital and fixed capital investments. These shortcomings imply that traditional accounting measures (like earnings and earnings per share) are not reliably linked to increasing the value of the company's stock price. When a business wants to determine the economic value of an investment, it discounts the investment's forecast cash flow by the company's cost of capital. This technique, known as discounted cash flow (DCF) analysis, is widely used in capital budgeting and lease versus buy decisions. Until recently, managers have generally been reluctant to extend the approach beyond piecemeal applications to an entire business plan. The shareholder value approach applies the DCF analysis to the business as a whole - treating it as a portfolio of cash-generating strategies...
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