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Recommeded: CEOs guide to corporate finance

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The CEO’s guide to Corporate Finance

Four principles can help you make great financial decisions—even when the CFO’s not in the room.

It’s one thing for a CFO to understand the technical methods of valuation—and for members of the finance organisation to apply them to help line managers monitor and improve company performance. But it’s still more powerful when CEOs, board members, and other nonfinancial executives internalize the principles of value creation. Doing so allows them to make independent, courageous, and even unpopular business decisions in the face of myths and misconceptions about what creates value.

When an organisation’s senior leaders have a strong financial compass, it’s easier for them to resist the siren songs of financial engineering, excessive leverage, and the idea (common during boom times) that somehow the established rules of economics no longer apply. Misconceptions like these—which can lead companies to make value-destroying decisions and slow down entire economies—take hold with surprising and disturbing ease.

What we hope to do in this article is show how four principles, or cornerstones, can help senior executives and board members make some of their most important decisions. The four cornerstones are disarmingly simple:

1. The core-of-value principle establishes that value creation is a function of returns on capital and growth, while highlighting some important subtleties associated with applying these concepts.

2. The conservation-of-value principle says that it doesn’t matter how you slice the financial pie with financial engineering, share repurchases, or acquisitions; only improving cash flows will create value.

3. The expectations treadmill principle explains how movements in a company’s share price reflect changes in the stock market’s expectations about performance, not just the company’s actual performance (in terms of growth and returns on invested capital). The higher those expectations, the better that company must perform just to keep up.

4. The best-owner principle states that no business has an inherent value in and of itself; it has a different value to different owners or potential owners—a value based on how they manage it and what strategy they pursue.


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Author:Richard Dobbs, Bill Huyett, and Tim Koller, McKinsey&Company

Source:https://www.mckinseyquarterly.com/Corporate_Finance/M_A/The_CEOs_guide_to_corporate_finance_2694#backpage