The Value Equation, explained in plain English

If you want to know how the world’s richest people got to be the world’s richest people, you first need to understand how the world’s most valuable companies got to be the world’s most valuable companies.

Because most American multi-millionaires — and all self-made American billionaires — achieve their wealth by owning stock in companies they start or work for. That single fact reframes how you should think about your career, your business, and your investments.

Worth more than it costs

Financially speaking, successful companies are those worth more than they cost to create. That is not an easy thing to do. In fact, most companies fall short.

The open secret for how a company becomes worth more than it cost is for the company to produce investor returns that exceed investor return requirements. When returns clear that bar, value is created. When they don’t, value is destroyed — no matter how impressive the revenue line looks.

Six variables

This is where the Value Equation comes in. The Value Equation reduces a business model to just six financial variables. The math is simple — middle-school arithmetic — and it’s driven by universal business financial relationships that hold true for any company, in any industry.

It starts by using those relationships to compute a company’s current investor returns. Then the framework incorporates the Universal Business Model, which takes current returns and adds growth variables to estimate total expected returns.

Why it matters to you

Understanding these basic relationships can help you no matter where you sit:

• If you want to start a business, it helps you optimize your model to deliver the highest investor returns and the most shareholder value.
• If you’re weighing career options, it gives you sharper insight into your financial and professional decisions.
• If you work for a business, it helps you evaluate its model — and the impact you might have on improving it.
• If you invest in stocks, it makes you a more knowledgeable shareholder, able to peel back the business models of the companies you own.

The Value Equation is the simplest way to understand corporate business model dynamics — something that should be central to any business school curriculum. But you shouldn’t have to be a graduate business student to understand it. This is important knowledge, and it needs to be shared with everyone.