Finance explained to my mother-in-law. Chapter III – Value creation

That CFOs are all boring, bald, eyeglass-wearing pain in the ass is an urban legend.

But there is no doubt that every company expects from Finance logic, rigour and a critical look when all the other company roles often privilege emotions:

  • the sales manager who wants to “give away” his products or services in order to increase sales
  • the union representative for whom the company’s only mission is to guarantee employment
  • the plant manager who yells, insults and punches when things don’t go the way he wants.

To introduce my point of view, I generally ask a simple question.

If you had 10, 50, 100 million euros at your disposal, would you invest them in a manufacturing plant with thousands of people, looming chimneys, environmental risks, strict safety rules and uncertain returns or would you buy yourself N residential properties in central Paris, London or New York where all you have to do to earn a good 5-6% net is put a rental ad on the Internet ?

Concluding with “And yet, thank God, our shareholders have guaranteed us a salary by choosing the first alternative. So try putting yourself in their shoes.”

No special effort or knowledge is needed to do so, because Finance is just a matter of common sense.

And common sense, in any case that of us Italians, says that you have to get the maximum result with the minimum effort.

The value of a company is therefore an equation with the numerator the result and the denominator the effort: when the effort tends to zero, the equation tends to infinity. The greater the result, the sooner you get at infinity.

By eye, without any scientific pretension, having to choose between maximizing the result and minimizing the effort, I would give priority to the effort.

The result is usually called EBIT or EBITDA (“Earning before interests and taxes” or “Earning before interests, taxes, depreciation and amortization”) while the CE or CI effort (“Capital employed” or “Capital Invested”).

So, the company that makes 100 of Ebit with environmental risks, chimneys, noisy machinery, a thousand people shed blood, sweat and tears will be worth less than the one that makes them by renting a few apartments in Paris.

Even more valuable will be the one that makes 100 of Ebit with just three geeks who spend their days playing table football in a warehouse in Silicon Valley after inventing something called Facebook.