What Are the Different Types of Residual Income Opportunities?

The RIM Residual Income Valuation Model, also known as the EBO model, was first proposed by Edwards and Bell in 1961, but it did not cause much attention in the theoretical community and was silent For a long time; in 1995, American scholar Ohlson elaborated this method systematically in his article "Revenue, Book Value, and Dividends in Valuation of Equity," establishing the value of corporate equity and accounting variables. The relationship between them makes this method regained the attention of the theoretical community and has become one of the most popular research topics in the financial and accounting fields in the United States in the past decade.

Residual income valuation model

Residual income

So-called

The basic formula of the residual income valuation model is:

"Residual income pricing focuses on the company's value creation process." Professor Payneman, a famous American accountant, believes that this model is the biggest difference between the traditional discounted dividend and cash flow discount model. The value of a company's investment lies in its ability to earn returns that exceed the cost of capital. The price-to-book value (P / B) ratio will increase as the company's ability to increase "economic value" increases; if the company cannot earn more than It is not surprising that the return on the cost of capital is that its stock price is lower than its net assets. It is precisely the capital market's correct reflection of its intrinsic value. Traditional business performance evaluation indicators usually include return on equity, return on total assets, and earnings per share. However, these indicators do not consider the cost of capital and cannot reflect the status of net capital gains and the value-added benefits of capital operations. A company showing a positive profit does not mean that the company's assets have been preserved and increased in value. The core of the residual income valuation model is that it starts from the interests of shareholders and evaluates whether the management and management activities of the company s management have created value for shareholders. Only when the company s net after-tax profit (after deducting after-tax debt interest) is greater than shareholders Only when the company's investment capital can obtain the necessary compensation in the market, can it be determined that the management and management activities of the company have created value for the company. From this point of view, taking the cost of equity capital as an element to evaluate the company's operating performance is the biggest difference between residual income and traditional financial analysis tools. According to the traditional "accounting profit" calculation practice, many companies' financial statements show that they are making a profit. But in fact, many companies are not really profitable because the "profits" they make are often less than the total cost of capital invested by the company. As a new accounting method and management concept, the residual income corrects this error; and it is clearly stated that managers must "pay for capital" just like paying wages. The emphasis on the cost of capital in the residual income model enables companies to avoid hidden losses. When a general enterprise invests, as long as the return rate is higher than the loan interest rate, it is considered a feasible decision; in fact, if the compensation required by shareholders is considered, the project's expected cash flow may not be fully met; it is measured by the method of residual income and invested in the project May suffer losses.

In addition, based on the concept of residual income, it is possible to better coordinate the conflicts of interest between the various departments of the company and promote the company's interests to the maximum. The company's production, marketing, procurement, and service is a complex system, and there may be conflicts of interest between various departments; especially when the company's resources are limited, this conflict is even more serious. If you think from the perspective of residual income, it will undoubtedly improve a better way to resolve this conflict. The achievement of different sector goals requires a certain investment. If it can create more residual income, it should be met first. If it cannot create residual income or generates very little, it can only wait in line. The decision-making criteria of the enterprise based on the residual income framework ensure the smooth implementation of corporate strategy. There are many sources of company value: being the first to develop new products, entering a new industry, investing in capital expenditures now that can benefit in the future, reducing production costs through innovation, and so on.

For the company's senior managers, it is not a lack of investment projects, but usually faces too many projects to choose from; each project manager will paint his own project wonderfully, because they are in the company's overall interests , Also has different private interests. How to choose a really good project in this way becomes a problem for senior managers? In the face of residual income, all these problems are easily solved. Using residual income as a financial measurement indicator, all decision-making processes boil down to one question: whether to increase residual income. Any enterprise has its growth life cycle, which has to go through the stages of start-up, rapid development, maturity and decline. Enterprises are in a fiercely competitive environment, and the high growth in the expansion stage will eventually be attributed to mediocrity. According to microeconomic theory, unless there are special technologies and industrial entry barriers, when an industry enters a long-term competitive equilibrium, all enterprises can only expect Get a return equal to the opportunity cost of capital, no more and no less. If some companies make economic profits, the economic rent of the company will be difficult to maintain for a long time due to the urge of new competitors to continue to join and the internal companies to expand production. Therefore, the extraordinary income of an enterprise may not be sustainable, that is, the period of residual income is generally not too long. Therefore, how to maintain the current level of residual income of the enterprise and continuously create new value has become the first issue of corporate strategic decision-making. The biggest source of residual income is undoubtedly proprietary technology and industrial barriers. Industrial barriers are not available to every enterprise. Innovation is the secret of most enterprises. Through brand, technology and service innovation, we will establish a more attractive market, build a stronger competitive position and competitive advantage, and finally establish a "perpetual motive for residual income." The core competitive advantage and correct decision criteria based on the concept of residual income are the basic requirements for the survival and development of the company, the inevitable need to ensure the company to create value, and the source of the company's everlasting foundation.