Measuring value creation

The previous chapter discussed how the financial statements can shed light on the growth of a business. It was shown that growth can come from either of two sources: reinvested profit or external funding. An important connection remains to be made, however, between growth and the creation of wealth, or value. As we shall see, growth is not necessarily a good thing. While we have established that a company becomes bigger by investing in additional assets, the issue we have yet to consider is whether this investment can be regarded as effective, in the sense that it creates value. Measuring value creation is therefore the subject of this chapter. We will start by making a distinction between the cost of making an investment and the return that is earned on that investment. We will then explore various factors that contribute to the return on investment.