SVA is an approach to Financial management developed in 1980s, which focuses on the creation of economic value for shareholders, as measured by share price performance and flow of funds. SVA is used as a way of linking management strategy and decisions to the creation of value for shareholders.
The investment, business and financial decisions, both strategic and operational, are identified which have impact on creation of value for shareholders. The factors called ‘value drivers’ are identified which will influence the shareholders’ value.
In order to understand value creation in a company, it is necessary to locate and understand where the value is created, which means identifying the value drivers of the business. A thorough understanding of the value drivers and their effect on the company’s future cash flow will help in managerial decision making to create value for shareholders.
Normally, there are hundreds of value drivers, each adding a fraction of value to total enterprise value, but understanding the key value drivers is one of the management’s most important task since it is clearly difficult to maximize value without knowing where it is created.
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Some of the key financial value drivers are as follows:
a. Growth in sales
b. Improvement of profit margin
c. Capital investment decisions, both working capital and fixed capital
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d. Capital structure decisions
e. Cost of capital etc.
The basic assumption of SVA is that a business is worth the net present value of its future cash flows, discounted at the appropriate cost of capital. SVA provides a framework for linking management decision and strategies to value creation. SVA insists the managers to take decisions which can create value for the shareholders.
A business can plan and manage its activities to increase value for shareholders, and at the same time, benefit other stakeholders. SVA requires the specification of a planning horizon i.e. number of years, for which cash flows are to be forecasted and discounted to present values.