Describe How Value-Added Is Calculated. to What Extent Are Value Added, Cashflow, and Profit Connected to a Company’s Sales Performance? Discuss Using an Extended Examples.

Topics: Value added, National accounts, Gross domestic product Pages: 5 (1653 words) Published: December 4, 2012
Describe how value-added is calculated. To what extent are value added, cashflow, and profit connected to a company’s sales performance? Discuss using an extended examples.

According to Gilchrist (Gilchrist, 1971) the value-added is a notion that companies should always be focused on. It can be defined as the measure of the amount of money created by a company. In economics and business languages, it is a term increasingly and wildly used in economic press or in politic speeches for example, especially in European countries concerned about their growth rate needed to maintain their level of living. Somewhat, when we speak about value-added, it is inevitable to address the critical question of labour costs which makes developed countries less competitive than emerging countries. For example, the idea of a social VAT takes its place here within political programmes designed to reduce the labour costs lying on companies. On one hand, we will describe the several ways to calculate the value added of a company, firstly with the subtractive and the additive perspectives and secondly with the traditional accounting calculation used by most economists. We will also explain how the value added of a country is calculated. On the second hand, we will use the value added framework to try to establish a connection between the value-added, the cashflow and profit in one side, and the company’s sales performance in the other side. To illustrate the point, the examples of Hermes and Nike will be taken throughout this paper.

On one hand, we will consider the company’s value-added. According to Cox (Cox, 1979), there are four constituents of the value-added for a company. Indeed, the deduction of the purchases of materials and services from the gross output (total sales revenue) gives the value-added. Once calculated the value added has to be distributed between wages, depreciation and operating profit. From this analyze, Cox assumes that it is possible to consider two different ways to calculate a company’s value-added for a given year: the subtractive calculation and the additive one. The subtractive method can be defined as follows: Value added equals to output minus input. The output is the total sales revenue which is calculated as the price of the good multiplied by the quantity sold. The input represents all the expenses relating to the purchase of materials and services. With the subtractive method, the value-added represents therefore a percentage of the total sales revenue. Otherwise, the additive method focuses on the distribution of the value added. It can be defined as follows: Value-added equals to labour costs plus depreciation plus operating profit. The labour costs are the cost of wages paid to workers (it includes social charges), those costs are usually the major costs of a business. According to Dodge (Dodge, 1997) the depreciation can be defined as “a decrease in an asset’s value caused by unfavorable market conditions”. The operating profit represents the earnings before interests and taxes. Those interests and taxes are payable to the bank (interests on loans), the government (several taxes) and mainly to the shareholders (dividends). The other way to calculate the value added of company is the traditional accounting calculation used by most economists: Total sales revenue minus wages and salaries, raw materials and capital costs equals to value added. According to Kay (Kay, 1993), this calculation can measures the competitiveness of a company and gives an index of its profit. Furthermore, it is important to know that a company can produce whether high value-added products or low value-added products:

According to the schema, we can understand that a company selling products made by others has a lower value-added than a company who produces and sells its own products.

On the other hand, we will consider the countries’ value-added. Thus, the sum of all the...
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