ECONOMIC VALUE FLOW

The figure above depicts the flow of value in an economic entity. Like oxygen, food and other necessities to a biological system, value measured in monetary terms is the essence of economic entities.

Where does it begin?

Before an entity can generate value by itself, some value from another entity has to be transferred to the entity. This is the formation period of the entity. Such transfer enables the entity to build its most fundamental components - capacities - that enable it to generate its own value and therefore exchange with its customers. The value transfer could be either as an asset or a consumable: these points reflect the options for finance injection. After the first exchange process, value flows through the entity either via the short term cycle without the long term cycle or through both cycles. (See the PCIX Grid)

Definitions:

-          Assets: Assets are long term embodiments of value ready to be used up (absorbed) in the value addition transformation processes.

-          Expenses: Expenses are periodic outflows from Assets to value addition transformation processes in the short term.

-          Products: These are short term embodiments of value resulting from the value addition transformation process in the short term; they are ready and available for exchange with customers.

-          Consumables: These are short term embodiments of value being used up (absorbed) in the value addition transformation processes.

-          Revenues: Revenues are short term embodiments of value resulting from the exchange process with customers and are ready to be absorbed in either the short term or long term value addition transformation processes.

-          Savings: Savings are the periodic inflows into Reserves for value addition transformation process in the long term.

-          Reserves: Reserves are long term embodiments of value still in the value addition transformation process in the long term not ready for absorption.

-          Leakages: Leakages are the unabsorbed (unused) periodic outflows from the long term embodiments of value - Assets and Reserves.

Economic Value Flow Reporting

The EVF Statement (Example)

DESCRIPTION	XAF	XAF
SHORT TERM
Revenue		10,000,000
Consumables:             - Revenue Generating[1]	(5,000,000)
- Resource Servicing[2]	(1,200,000)
- Inescapable Obligations[3]	(300,000)
Total Consumables		(6,500,000)
Savings		3,500,000
Expenses:        - Assets A	800,000
- Assets B	200,000
Total Expenses		(1,000,000)
Gross Operating Value Added (Eroded)		2,500,000
Leakages:        - Assets	300,000
- Reserves	100,000
Total Leakages		(400,000)
Net Operating Value Added (Eroded)		2,100,000
LONG TERM
Opening Assets		2,000,000
Less:                 - Expenses	(1,000,000)
- Leakages	(300,000)
Add:                - Transfers from Reserves	1,800,000
Net Periodic Change		500,000
Closing Assets		2,500,000
Opening Reserves		2,000,000
Add:                - Savings	3,500,000
Less:                 - Leakages	(100,000)
- Transfers to Assets	(1,800,000)
Net Periodic Change		1,600,000
Closing Reserves		3,600,000
Total Long Term Resources		6,100,000

Performance Indicators

1.      FORESIGHT ACCURACY (FA)

Economic sustenance depends on an entity’s ability to generate value for itself. However, the context in which value is being generated is dynamic and most often very uncertain. Managers and other decision makers act based on their hypotheses about eminent changes in the future. For their decisions to yield returns to the entity, those hypotheses have to be matched with the reality at that point in the future. Otherwise, the resources allocated will be lost without any return to the entity.

a.       Objective

The objective of Foresight Accuracy (FA) is to determine the extent to which the entity’s decisions in the past enable it to capitalize on and benefit from the opportunities created by the prevailing context. This goes a long way to establish the credibility of the decision makers.

b.      Equation

FA        =	Cumulative Net Operating Value (within the Strategic Timeframe)
	Total Resources Employed (within the Strategic Timeframe)

For the hypothetical example, FA is 20.79% or 0.2079.

2.      VALUE REPLACEMENT (VR)

Economic value transformation is a dynamic process. In the transformation leading to value addition, an entity absorbs considerable value. What if the total value outflow is less than the value inflow? An entity cannot sustain itself if the value inflow is less than the value outflow indefinitely.

a.       Objective

The objective of Value Replacement (VR) is to determine the extent to which an entity’s value absorbed is being replaced by it adds through its transformation processes of value addition in the short term (production).

b.      Equation

VR        =	Savings
	Expenses + Leakages

                                    VR for the example is 250% or 2.5 times

3.      MARKET VULNERABILITY (MV)

Fluctuations in the economic context create a degree of vulnerability to all entities operating within that context. Such vulnerability is expressed in the losses incurred as a result of changes in the market place.

a.       Objective

The objective of Market Vulnerability (MV) is to determine the extent to which an entity can withstand contextual and temporal fluctuations.

b.      Equation

MV      =	Leakages
	Closing Reserves

                                    MV for the example is 11.11%

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[1] Revenue generating consumables include the cost of raw materials and direct labour in traditional accounting.

[2] Resource servicing consumables are consumption geared at maintaining the effectiveness of resources. It may include: repairs and maintenance of infrastructure, marketing costs, overhead personnel, cost of branding, cost of maintaining supply channels etc.

[3] Inescapable obligations consumables are those consumables are given with or without operations such as licence fees, fixed taxes etc.

RELATIONAL RESOURCES

Humanity has always held a firm conviction that no man is an island. However, until the rise of powerful business models built on the interaction of individuals; the inherent value of communities was taken for granted. The rise in popularity of social and professional networking facilities on the internet is evidence of technology facilitating a long held survival mechanism of humans – relations and their interactions. In social psychology, there is a formal study of a special kind of capital – social capital, it proves that beyond talent, information, finance or material goods, there is another class of resources that counts because all these must relate and interact with one another. (Social Capital Wikipedia.org)

DEFINITION, LOGIC AND EXAMPLES

A Relational Resource is the resource pool and its associated links between two or more entities established by mutual consent for their contribution to, sharing of and making use of the resource pool.

A relational resource is the integral unit of entities connected to one another

Examples of Relational Resources are Communities, Markets, Networks, Partnerships, Consortiums, and Supply Chains etc.

BASES OF VALUE

-          Connectivity: This is the extent to which member entities are linked to one another and to the pool of resources.

-          Trust: This is a measure of the extent to which members have confidence in and reliance on the responsibility and ability of other members and the resource pool.

Where the members do not have confidence in and cannot rely on the responsibility and ability of other members, there is bound to be little or no interactivity within, hence rendering the population and established connections useless.

Individuals learn to trust their communities or other institutions. Most often, the trust is dependent on the historical performance of the community.

-          Equity: Equity is a measure of the extent to which members perceive a state of justice and impartiality among themselves in relation to the resource pool.

Instinctively, some members expect to gain more than their share of contribution to a pool. However, none will be pleased to know that they are being treated unfairly while another member is receiving favors. As such, balance is reached only when the relational resource metes out to members what is merited based on defined and transparent objective criteria.

The rule of law is the main tool which has been used in the past to build equity in a community. Clear, explicit, public and active legal systems assure members that just as they cannot perks; no other entity is taking unfair advantage of the system. As such, whatever is merited to them shall be fully possessed by them.

-          Commitment: This is the extent to which members are willing to engage and be engaged with other members and the resource pool.

In Africa, there is an old saying that “tightfisted hands get nothing”. This is not true only for the sages of old; it is the same for us in this day and age. Commitment is mutual; members not willing to engage others in their affairs will hardly be engaged in the affairs of others. Societies where people engage others in their affairs and are willing to be engaged in the affairs of others advance faster than those with less commitment. It is an infinite chain of providers and customers. In receiving an engagement, an entity is a customer, while in giving an engagement it becomes a provider. (3)

-          Delay: This is the minimum time taken by a member entity to make a contribution to, share or make use of the resource pool. (2)

Time is a critical factor in building communities. Every minute in waiting is a minute wasted.

-          Critical Effort: This is the human energy and resources expended by a member entity in order to make a contribution to, share or make use of the resource pool.

-          Bureaucracy: These are the number of procedures needed to be taken by a member entity to make a contribution to, share or make use of the resource pool.

FINANCIAL RESOURCES

For more than two millennia, the world has relied on some form of financial resource for commercial activity. The complexity of the nature of financial products, especially in the advanced countries, is a hallmark of humanity’s achievement in that respect. Today, we have financial resources that range from bets through insurance policies to equities. Financial resources are ubiquitous so much so that they are the de facto instruments for the store of economic value. This function has made it such that all other resources have been forced within the financial valuation model as if they all behave alike.

DEFINITION, LOGIC AND EXAMPLES

A financial resource is the quantitatively expressed and implied information of a time-based or context-based commitment from one person (the liable authority) to another person (the holding entity).

Examples of financial resources include: Cash, Stocks, Bonds, Insurance Policies, Bets, Derivatives, Options, Swaps, and Mortgages.

Unlike other pieces of information, financial resources attain their distinction from the contractual agreement and relationship between the holding entity and the liable authority. The Liable Authority issues the financial resource and is responsible for its performance stated in the contract; to the Liable Authority, the financial resource is a liability. The Holding Entity holds the financial resource and has the right to use it in exchange for goods, services or opportunities within the jurisdiction of the financial resource; to the Holding Entity, the financial resource is an asset.

In terms of financial resources, all assets held have corresponding liabilities. Here, we validate the concept of debit and credit. However, these exist in different books. In the record of the Liable Authority, the financial resource is a liability, whereas in the books of the Holding Entity the same financial resource is an asset. For instance, MTN Cameroon issues a bond which has a face value of XAF 10,000 and is bought by Ms Iya; in MTN Cameroon’s books, there is a liability (Credit) of XAF 10,000 to Ms Iya, while in Ms Iya’s, there is a corresponding asset (Debit) of XAF 10,000 with MTN Cameroon.

Also, it is not a must that the value of the asset equals to the value of the liability except for their fiat values.

The Table below outlines examples of financial resources, the holding entities and the respective liable authorities.

No.	Financial Resource	Holding Entity	Liable Authority
1	Cash	Citizens	The Government
2	Treasury Bill	Bill Investors	The Government
3	Corporate Stock	Shareholder	Corporation
4	Corporate Bond	Bondholder	Corporation
5	Insurance Policy	Insured	Insurance Company
6	Bank Account Deposit	Account Holder	Bank
7	Bank Credit	Bank	Debtor
8	Car Mortgage	Mortgage Lender	Car Owner

Table 1: Financial Resource, Holding Entity and Liable Authority

BASIS OF VALUE

-          Visibility (V): This is the extent to which the performance of the liable authority can be monitored and evaluated by the community of holding entities.

In holding a financial resource, the Holding Entity is at the mercy on the performance of the Liable Authority. As such, in order to reduce the vulnerabilities, it is important that the Holding Entity is well informed of the performance of the Liable Authority with respect to the financial resource. Such performance is particular to the terms established during the creation of the financial resource.

Money for instance, though we are born to take this for granted, is a contract between the state (monetary union) and its citizens. In this contract, the citizens expect that the government will maintain good policies that ensure its continuity, hence the continuity of the money they are backing. For the citizens to know how well the government is fulfilling its part of the bargain, they must be informed of its performance in the areas through which they perceive is critical to the continuity and security of the government.

This concept of visibility is well understood and it drives the thinking behind investments in publicly traded companies. The whole rationale is that investors, who are the holding entities, are informed about the corporation’s relative performance in terms of profitability, sustainability, liquidity and any other measure that is deemed important for it to continue fulfilling its obligations for the financial resource it backs.

The concept of visibility establishes the need for information regarding the performance of the Liable Authority to the public of Holding Entities. Hence the need for business accounting and other business performance measures as well as their associated reporting standards.

-          Assurance (A): This is the degree of certainty that the liable authority will maintain responsibility over the financial resource and fulfill the ultimate exchange agreed upon at the initial exchange.

The essence of Visibility is to ascertain the level of confidence the holding entity is willing to attribute to the liable authority. Assurance is the amount of confidence the holding entity has allotted to the liable authority based on the available information on the liable authority’s performance. Assurance is at the core of the performance of the financial resource. In cases where the public of holding entities have very low confidence levels for the liable authority, the inherent value of the financial resource plummets.

When a firm maintains either a cash flow deficit or operating losses for a longtime, it gets investors to worry about it meeting with its pledges.

-          Transferability (T): This is the degree of certainty that the community of holding entities will continue accepting the financial resource in exchange from one another.

The relative nature of the performance of financial resources makes it such that their relative value fluctuates over time, place and context; irrespective of the performance of the liable authority. Such flux thus makes it such that it becomes impossible to hold the same financial resource indefinitely.

An implicit assumption on all financial resources is that they will be exchanged at some point in the future when the holding entity has an alternative other than holding the financial resource. Thus transferability is an implicit trait with all financial resources.

-          Financial Cover: This is a pledged compensation the liable authority of a less performing financial resource makes during the initial exchange to the liable authority of a more performing financial resource in an exchange between the two financial resources.

Financial Cover arises only in exchanges involving two financial resources of different inherent and relative performances. Traditionally, the compensation is along the line of trade-off between Interest and Influence.

o   Interest is the amount of value the LA of the less performing financial resource is willing to part with on a periodic basis in holding and making use of the more performing financial resource.

o   Influence on the other hand is the degree of control (governance, oversight, authority) the LA of the less performing financial resource is willing to take from the LA of the more performing in exchange for keeping and using the more performing financial resource.

-          Fiat Value (FV_o): This is the assumed and legally endorsed numerical value of the financial resource considered at the point of infinity (long term) established during the initial exchange and eventually at the ultimate fulfillment.

Fiat Value is fixed over time, context or holding entity. Generally in contemporary and classical finance, the par value of stocks and bonds are the fiat value, while the Fiat Value of Insurance Policies is the Insurance Cover.