The Journal

I was recently talking to local practitioner about ways to add value to the firm. During the course of the conversation I realized that he and I were talking about two different concepts. I was talking about adding value to his net worth and he was talking about the economic concept of value added activities.  I thought this would be a perfect opportunity to discuss the difference between the two and to provide a couple examples of how you can add value to your practice.

Adding Value to the Firm

The financial concept of adding value to the firm relates to maximizing the market value of the existing owners’ equity. Good financial decisions increase the market value of owners’ equity and poor financial decisions decrease owners’ equity.

The easiest way to understand the concept of adding value is to consider the role of the financial manager of a corporation. The financial manager makes decisions on behalf of the stockholders. Stockholders ultimately only care about how the decisions affect their net worth. This means that a financial manager’s only true goal is to increase the value of the share of stock.[clear][divider]

The Economic Concept of Value Added

Adding value to the firm is different than the economic concept of value added activities.  Value added activities for economists are activities that increase the difference between the sale price and the cost of production. Value added is a marginal increase of value over the cost of production; it is a measure of the increase in value per unit.

It would be easy to think that value added activities are the same as adding value to the firm. However, value added activities are more closely related to profit.

The Two Concepts Are Not the Same

Let’s take an easy example, growth stocks.  Companies that are growing are often not profitable. This does not mean they are worthless.  Remember when eBay chief executive Meg Whitman told reporters that the company did not expect the company to be profitable for years?

Add Value to Our Practices

As practitioners it is sometimes hard to consider what we can do to increase the value of our practice beyond increasing billable hours and decreasing our fixed costs. However, these actions may lead to higher profitability but do not necessarily add to our net worth.

Investing in capital equipment and realty are examples of how we can increase our net worth. Finding ways to make your practice “work” without you can also add to your net worth. The property owner who invests in starting virtual offices can add to their net worth.  Virtual offices are a bundle of rights and services. Virtual offices produce cash flow that is not dependent on billable hours. This cash flow stream can be sold, thus increasing owners’ equity.