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Value Added and the Value Added Scoreboard - Page 2

VALUE ADDED (VA)

Value added has been used as a performance indicator by financial managers for a number of decades and makes reference to a sixties article in the Financial Times – “How to measure output” by Ronald Gilcrist of Urwick Orr and Partners.

Value added was defined by Gilcrist as “The value of sales less the cost of all the materials, process materials, heat, light, power and all other ‘bought out’ items.” It constitutes the fund which the company applies to:

  1. pay employees
  2. pay providers of capital
  3. pay government taxation
  4. maintain and expand assets

Gilcrist’s paper centred on the notion of measuring output and the relationship of productivity and incomes.

In the early ‘nineties’ Dennis Henry of P E International focused research on the productivity of the top 250 companies in Europe. Henry’s measure of performance was to take each firm’s value added and to divide this by labour costs. This measure of value added per £ of employee costs was one of three criteria he used in assessing company performance. He stated that “this shows how effective a company is in mobilising its human assets to generate wealth”.

His survey revealed that the UK companies within the 250 were league leaders. Companies then as: Glaxo, Tarmac, BT, Guinness and ICI showed ratios of 2.8, 2.29, 2.12, 3.09 and 1.89. The average measures for the rest of Europe were in the range 1.3 to 1.8.

The results at that time begged the question “If the UK scores highly, why is it that some economies in the survey out-perform the UK’s?” Part of the answer may lie in the fact that the best British companies can hold their own against any international competition but the problem with the British economy is that there are too few of them, particularly in manufacturing.

In recent times the DTI published the first ever value added scoreboard which provides a measure of the wealth created by each of the top 500 UK companies and the top 300 European companies by value added. Patricia Hewitt the Secretary of State for Trade and Industry states that “It is essential that business and government work together to raise productivity and value added throughout the economy”. The value added scoreboard offers companies an excellent new benchmarking tool to compare their performance on value added, on productivity and on more conventional measures with the best companies across Europe.

Before considering the way in which the value added scoreboard uses the concept as a basis for various measures, we need to consider the format of a value added statement to show clearly the make up of value added and its distribution. There are also some interesting underpinning factors to be considered.

In the mid-seventies the Accounting Standards Steering Committee considered a discussion paper “The Corporate Report”. Its objective was stated as “The purpose of this study is to re-examine the scope and effects of published financial reports in light of modern needs and conditions”.

The paper was published in 1975. Section 6, “The Scope and Content of Corporate Reports” included the value added statement, 6.7, and stated that “The simplest and most immediate way of putting profit in proper perspective vis-à-vis the whole enterprise as a collective effort by capital, management and employees is by the presentation of a statement of value added (that is, sales income less materials and services purchased)”. Value added is the wealth the reporting entity has been able to create by its own and its employees’ efforts. This statement would show how value added has been used to pay those contributing to its creation. It usefully elaborates on the Profit and Loss account and in time may come to be recorded as a preferable way of describing performance.

At one time the accounting profession was strong in support of the concept with both ACCA and the Scottish Institute sponsoring research papers. Some would argue that the ASB should have developed a FRS on the topic. It is interesting to note that IAS 1, Presentation of Financial Statements has both, by ‘function’ or by ‘nature’ formats and the ‘nature’ format allows value added to be easily determined. (IAS = International Accounting Standard.)

A DoT’s consultative paper “The Future of Company Reports”, published in 1977, took the view that companies should be compelled to include a value added statement in their corporate report. However the EEC Fourth Directive changed the situation because it required large and listed companies to disclose extra information on the profit and loss account. The DoT’s document in 1979 “Company Accounting and Disclosure” then took the view that since most information required to prepare a statement would have to be published anyway, legislation compelling companies to produce a statement would no longer be necessary.

The 1985 Companies Act embodied the requirements of the Fourth Directive and required disclosure of:

and value added can be determined from this information with the move towards harmonisation, and the use of IAS’s by all listed companies in Europe by 2005, there is an excellent opportunity to focus the concept as the subject of an accounting standard; or at least incorporate the concept within one.

Value added cannot at present be calculated for US or Japanese companies from published accounts since they do not provide information on employee costs.

The following example illustrates the preparation of a value added statement:

Extract from Profit and Loss Account of Hawsker Feeds Ltd
for the year ended 31 December 2001

 

 

£000's

 

 

 

 

Turnover

7000

 

Cost of sales (* see below)

5175

 

Profit before interest and tax

1825

 

Interest

625

 

Profit before tax

1200

 

Taxation

300

 

Profit after tax

900

 

Dividends

250

 

Retained Profit

650


 

 

£000's

 

* Costs comprise:

 

 

 

 

 

Wages, salaries and employee benefits

1800

 

Depreciation

375

 

Other bought out items

3000

 

 

5175

NB: Capital and Reserves:
31 December 2002
£4.8m

Hawsker Feeds Ltd
Value Added Statement year ended 31 December 2002

 

 

£000's

 

 

 

 

Turnover

7000

 

Less bought out materials and services

3000

 

Value added

4000


 

Applied as follows:

 

 

 

 

To pay employee wages, salaries and other benefits

1800

 

 

 

 

To pay providers of capital:

 

 

 

 

 

Interest

625

 

 

 

Dividends

250

 

 

 

 

 

 

875

 

To pay government corporation tax

300

 

 

 

 

 

 

To maintenance and expansion of assets:

 

 

 

 

 

 

 

Depreciation

375

 

 

 

Retained profit

650

 

 

 

 

 

 

1025

 

Value added

 

 

4000

Value added per £ of employee costs = 4000 / 1800 = 2.22.

It is useful to contrast the International Accounting Standard IAS 1 'By Nature format'.

Income Statement

£000's

£000's

 

 

 

Revenue

 

7000

 

 

 

Increase in inventories of finished goods and work-in-progress

 

200

 

 

7200

Raw materials and consumables

2900

 

Staff costs

1800

 

Depreciation

375

 

Other operating expenses

300

 

 

 

5375

Profit from operations

 

1825

Interest payable

 

625

Profit before tax

 

1200

Income tax expense

 

300

Net profit for period

 

900

Value added can be determined as:

 

£000's

£000's

 

 

 

Revenue

 

7000

 

 

 

Less:

 

 

Raw materials and consumables

2900

 

Other operating expenses

300

 

 

 

3200

 

 

3800

Add back increase in inventories of finished goods and work-in-progress

 

 

200

 

 

 

Value added

 

£4000

Value added is a useful variant when considering management ratios. Not only can we measure per Gilcrist’s thesis, the value added per employee, which is indicative of the contribution of the company to the GDP but we can use the concept in Capacity Utilisation Ratios. If we consider the model:

Operating Profit %
Operating Assets

It could be said that some companies would use this to monitor performance of a division showing asset turnover and profit margin as the principal factors affecting this.

A further variant is to use value added instead of sales:

Figure 1

The value added/operating asset ratio is regarded by many as an indicator of capital productivity, just as value added/labour cost is a measure of labour productivity. Ideally one would hope both ratios were rising. This measure could be used favourably to motivate divisional management as value added is an excellent performance measure when considering the productivity of labour and capital.

The profit/value added ratio is a measure of that portion of the wealth created, which is available to pay providers of capital, taxation and maintain and expand assets.

The ratio can then be sub-divided to show:

Dividends/value added, measure that part of wealth creation which is of immediate benefit to shareholders, although they also benefit from the retention of profit which in the longer term should enhance the capital value of their stakeholding.

Tax/value added measures the proportion of wealth creation which is payable in corporation tax.

Depreciation and retentions/value added measures, the funds generated internally from the operating activities of the company. This ratio can be said to measure the flexibility or ability to change the company possesses.

The performance indicators for Hawsker Feeds Ltd year ended 31 December 2002:

Ratio

 

 

 

 

 

 

 

 

 

Operating profit %

 

1200

x

100 / 1

Operating assets

 

4800

 

 

 

 

 

 

 

 

=

25%

 

 

 

 

 

 

 

Operating profit %

 

1200

x

100 / 1

Value added

 

4000

 

 

 

 

 

 

 

 

=

30%

 

 

 

 

 

 

 

Value added

 

4000

 

 

Operating assets

 

4800

 

 

 

 

 

 

 

(no of times)

=

0.833

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

?

Dividend/value added

250

=

6.25%

 

 

4000

 

 

 

 

 

 

 

?

Taxation/value added

300

=

7.5%

 

 

4000

 

 

 

 

 

 

 

?

Depreciation and retention/value added

1025

=

25.6%

 

 

4000

 

 

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