What is Value?

The value of a company is like the price of produce at your local grocery store…

Grocery stores price produce in different ways. Some fruits and vegetables are priced per item, while others are priced per pound. Either way, the grocery store is attaching value to the item based on what it thinks the product is worth. Similarly, there are different ways to attach value to a company, but each method is an effort to determine what the company is really worth.

Value in corporate finance refers to the amount of money a business or asset is worth. There are many ways of determining value. In the cases of businesses, it could be as simple as identifying the book value of a company by subtracting its liabilities (debts and financial responsibilities) from its tangible assets. Tangible assets are items the company owns that have a concrete monetary value and usually a physical form, like equipment or cash.

Another type of value is market value. This is the amount that someone is willing to pay for the company (or the amount that shareholders are willing to pay for its stock). Finally, the value of a company can be determined by the amount of profit and wealth it provides to shareholders.

While the value of a company is often measured in dollars, there are other ways that companies can create value. Some businesses focus on creating value for customers, employees, and the community by prioritizing business ethics and a socially conscious business model. This approach can sometimes create both societal and economic value in the long-run and give companies a competitive advantage.

Creating value within a business can mean different things. Traditionally, many have considered the primary purpose of a company to be maximizing profits for shareholders. After all, officers and directors of corporations have a fiduciary duty to their shareholders, meaning they have a legal and ethical responsibility to act in their best interest. In general, that means creating profits for them.

Some economists argue that instead of focusing on shareholder value, companies should focus on stakeholder value. Shareholders are one among a corporation’s many stakeholders (those with an interest in the company who may be affected by its business decisions). Other stakeholders include customers, employees, suppliers, and the community.

Rather than focusing only on creating value for shareholders by increasing profits, businesses can choose to increase value for other stakeholders at the same time. The theory of the triple bottom line follows this line of thinking, arguing that companies should measure the value they provide in three different areas: profit, people, and planet.

First, companies can create value by maximizing profits for shareholders. Profit is the difference between revenue and expenses. So at the most basic level, the key to maximizing profit is to either increase revenue or reduce expenses.

When it comes to creating value for other stakeholders, companies can do this by practicing corporate social responsibility. That involves integrating concern for society and the environment into a company’s business model.

For example, companies can focus on ethical treatment of employees, customers, suppliers, and the surrounding community. They can do this by providing excellent customer service, sourcing from suppliers with fair working conditions, or donating to organizations that support the local community, among other things.

On the environmental side, companies can find ways to reduce waste, pollution, and reliance on fossil fuels. In an age where consumers increasingly care about corporate social responsibility, prioritizing it can enhance a brand’s reputation and attract customers and talent, resulting in financial value as well.

Value creation in a business is important on multiple levels. First, businesses that don’t create financial value for their shareholders are unlikely to stay in business long. On top of that, public corporations have a fiduciary responsibility to their shareholders, which means they have a duty to put the interests of investors first. In most cases, that means increasing profits.

Intrinsic value is how much a reasonable investor would pay for a business or security, taking account its level of risk. It measures the value of an asset today based on expected future cash flows and discount rate (how much you’d earn if you invested in something else with a similar level of risk). Some forms of valuation compare a company to others, but intrinsic value considers the company on its own.

One of the most popular valuation models for determining an asset’s intrinsic value is discounted cash flow (DCF). This valuation method suggests that, the higher and more predictable the future cash flows of an asset are, the higher its intrinsic value will be. The formula for calculating the intrinsic value of a company or asset is:

• n = the life of the asset
• E(CF) = expected cash flow during a particular period
• r = the discount rate, which accounts for the level of risk associated with the investment opportunity

There’s certainly a bit of guesswork involved when it comes to using discounted cash flow to determine intrinsic value. Because the formula works with future cash flows and not past or present cash flows, there’s plenty of room for error. As a result, five different analysts could figure out discounted cash flow and come up with five different intrinsic values.

Book value and market value are two of the most common methods for assigning value to a company or a stock. Book value is one of the simplest ways to determine the value of a company, because you just need to take a look at its balance sheet. The book value of a company is essentially its net worth — It’s the difference between a company’s assets and liabilities.

Because it’s so simple, book value doesn’t necessarily tell the whole story about the value of a company. For example, it doesn’t factor in future earnings, nor does it account for intangible assets, like goodwill, brand recognition, or reputation.

The market value of an asset or company can be a bit more subjective, as it represents the price that someone would pay for it. An easy way to think about market value is in terms of real estate. There’s no handbook or math equation that says how much a house is worth based on the square footage and number of rooms. When a real estate agent is putting a house on the market, they check out recent selling prices for comparable homes to figure out the listing price. What it actually sells for is based on how much a buyer is willing to pay and a seller is willing to accept.

In the case of publicly traded companies, there’s an easier way to figure out the market price: market capitalization. When someone buys a share of stock, they’re purchasing ownership in the company. To determine the market value of a company, you can multiply the number of shares outstanding by the current stock price.