Methods Used to Calculate Value Added - Essay Example

? Methods Used to Calculate Value Added and How Value Added Contribute Towards Understanding the Connections between the Business and Its Product Markets   Essay Date 1250 words   Name Institution The fundamental concept of measuring performance and income of an economic unit or body is based on the value added by various economic activities. It is particularly after the World War II that the United Nations went farther to develop standardised national value-added concept calculations. Value added is described as the measure of performance of a given economic entity.1 This paper describes the methods that are used to calculate the value added and the connection that a business has to its markets with respect to value added concepts. Value added concept of income measurement has been viewed as the increase in the wealth of an economic body. It is traditionally rooted to the evaluation of national income in macro economics, measured by national economy productive performance.2 This concept is referred to as National or Domestic product and represents a specific period’s national economy. This is a common use of this concept but it has also been applied in many other different areas of business operations and economics as a positive performance and economic gauge. This makes value added a measure and indicator of an economic entity’s performance and has a fairly long period of application in the field of economics.3 Value added represents a calculated value, and for this reason, it is well related to accounting. It is also contrasted from the traditional calculation of income in that, it can be and has been used in all the three accounting systems i.e. managerial accounting, financial accounting and the national accounting system. It is also distinguishable from income computation whereby value added is constantly described internationally as a difference of expenses from revenues. It can be defined in two ways that will be discussed below and this gives value added concept another critical characteristic commonly known as the dichotomy of value added.4 Subtractive method is the first method of calculating the value added and it is defined as: Value Added (VA) = O – I. Where O = Output; I = Input. This means that when being compared to accounting income, it is perceived as the net figure. The value expressed is the value that an economic body, such as a person, an industry or a company adds to the products and services it purchased or received from other entities during its creative or own productive economic activities.5 In the second one, additive method, the value added is represented by the total sum of the distributed parts that constitute the created wealth. This is done with respect to the reality that all the created wealth is well distributed i.e. by being allocated in some way. When considering a company, value added calculation is defined as: VA (Value Added) = RE + RG + RCP + NAP. Where RE = Remuneration of employees; RG = Remuneration of government; RCP = Remuneration of capital providers; NAP = not appropriated income i.e. retained earnings.6 The two formulas above disclose the characteristic content that value added concept has. This concept can be divided into social aspect, represented by the additive method, and performance aspect which is articulated by the subtractive method. This shows that in addition to economic information given by this concept, value added also offers social information through identification of the part of the yield that goes to every contributor of the whole process in a company.7 Value added concept has evolved besides its historical principal function in national accounting to several other uses and applications in the three; financial, national and managerial accounting. The two sided feature of value added i.e. performance and social characteristic, is depicted clearly by the concrete and possible applications. Hence it has been argued as a way to estimate productivity of an economic body through their way of using productive factors.8 This makes the value added concept to be used as a significant output outline because of its influence to efficiency which is a critical objective of economic performance. The efficiency relationship with input and output is what, in the process, influences the expansion of a products market owing to increased productivity.9 Defined as wealth, value added is related to the size of an economic body and is considered as a critical pointer of growth of the economic entity. Also the role of a company in economic production is expressed by the value added concept. When value added is related to the total amount of output of an economic entity, again this indicates the structure of business activities of an entity. This is illustrated through vertical integration.10 Value added can be used to measure productivity. Several measures were suggested in the recent years. This involves ways of selecting value added ratios and later matching different levels of management with specific productivity ratios to their needs. Value added also helps a firm to understand that when its earnings are expanding, it does not inevitably indicate increase in a value or the price of its stock. Economic value added points to the stockholder value to be the goal, this makes the cost of capital or returns of the stockholders the unit of measure. Motivated-based economic value added therefore, lines up the attention of the employees, managers and stockholders. From research, it has been found that companies implemented value added concept, increased their market value above peer by 50% over five years.11 This economic value added being the true measure of profits in a company, implies that it has an objective of which business part utilises best their allocated assets to produce returns and optimise stockholder value. To achieve value added concept, managers are forced to centre their attention on optimising stockholder investment and real wealth creation which simply suggests that value added will increase the company’s market value.12 Economic added value has also been observed to focus mainly on what managers can influence in an organisation rather than what they can not influence. The measure to make this possible should distinguish between the financial inputs and the value created as an output. This makes the weighted average cost of capital to be an excellent standard by which the process of management and all ventures should be measured.13 This implies that economic value added is needed for a meaningful measure of finance compared to other measures. Performance should be considered as a backbone of business. This is because individuals manage what they measure and thus value added can create a basis of a clearer and responsible management system. This can be more successful especially when combined with other powerful essentials to improve it at every stage, function and activity and at the same time being independent of geography. The combination here results to transparency, responsibility and accountability through assessment of performance and healthy control.14 Value added concept can be tricky when deciding to implement it. Therefore, a company is at risk when the implementation is done partially, this is because this concept cuts across all aspects of the business, and thus it requires a whole-hearted decision to implement it so as to avoid failure. As explained, when this concept is implemented to the expectation, its focus on the capital and the stockholders of a given company results to improved efficiency and thus increased profits. References Lambert, D. M. Supply Chain Management: Processes, Partnerships, Performance Supply Chain. Management Inst, 2008. Maher, M. W., Stickney, C. P. & Weil, R. L. Managerial Accounting: Intro to Concepts Methods Uses 10e. Cengage Learning, 2007. Schon, D. The Relevance of Discounted Cash Flow (Dcf) and Economic Value Added (Eva) for the Valuation of Banks. GRIN Verlag, 2007. Tucker, I. B. Survey of Economic. Cengage Learning, 2010. Read More