In this new course taken from my Complete Guide to Business Management, We will discover together what the added value, which is one of the intermediate management balances. The goal: to become an expert in management and corporate finance, especially aimed at beginners, managers and entrepreneurs.
This content is part of the course “Business Management for Entrepreneurs: A Complete Course to Better Manage Your Business” find it on Tulipemedia.com 💰📈
Definition of added value
There added value (VA) is an Intermediate Management Balance that shows the gross wealth created by a company.
Intermediate Management Balances (IMBs) are "sub-categories" of the income statement: they break it down into several indicators, allowing for an interpretation of how the profit or loss is calculated and what costs the company more or less. They serve both as a way to draw conclusions from a given financial year and as a decision-making tool.
And among these GIS, we find the added value, which corresponds to the new wealth produced during the company's production process, and which therefore translates the added value generated by the company through its activity.
More specifically, it's the difference between what the company sells or produces, and what it buys from third parties to function. And the result will give the share of wealth that will be distributed to employees, shareholders, the administration, and lenders.
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When a company has multiple activities or breaks down its accounting by product or service category, it can then perform calculations of added value per segment to identify What are the main sources? value creation.
Added value and GIS table
The added value is located quite early in the GIS table:
Turnover (TO)
↓
+ Stored/Fixed Production
↓
= Production of the exercise
↓
– Consumption of goods and services from third parties
↓
= ADDED VALUE
↓
– Staff costs
↓
= Gross Operating Surplus (GOS)
Value added (VA) is therefore a part of the result, and a part located early in the breakdown of the result. To calculate it, we base it on the production for the period (which includes the value of goods and services sold, and the value of products stored and fixed assets), and we deduct intermediate costs, that is to say the consumption of goods and services from third parties.
Value-added formulas
Put simply, the formula for added value is as follows:
VA = Production – Intermediate Costs.
But in calculating value added, it is crucial to distinguish between two types of companies: trading companies, and industrial companies.
Value added of trading companies
Trading companies resell what they buy, without transformation. In this case, the formula for value added is as follows:
VA = Gross profit – Other external expenses
With :
- Gross profit margin = Sales of goods – Cost of goods sold (COGS)
- CAMV = Purchases of goods – Change in inventory of goods
- And Change in merchandise inventory = Ending inventory – Beginning inventory
Regarding stock variation, here is some additional explanation to make it perfectly clear:
- If the ending stock is greater than the beginning stock, this means that the company has not yet sold this additional stock recorded at the end of the financial year. However, the Cost of Goods Sold focuses on the value of goods sold and not held in inventory. Therefore, in this scenario, the value of the change in inventory is positive and is thus subtracted from the calculation.
- If, on the other hand, the ending stock is less than the beginning stock, this means that The company has "sold out" all or part of its stock between the beginning and the end of the fiscal year., The value of this change is therefore added, as it represents a portion of the purchase cost of the goods sold. In the calculation, the value of the change in inventory is thus negative, resulting in an addition rather than a subtraction in the CAMV formula.
📌 Numerical example (commercial company)
Let's take the example of a clothing store, which therefore engages in buying and reselling:
- Sales: €300,000
- Purchases of goods: €180,000
- Initial stock: €40,000
- Final stock: €30,000
- Other external expenses: €25,000
First, let's calculate the change in inventory:
Change in stocks = Final stock – Initial stock = 30,000 – 40,000 = – €10,000.
Next, let's calculate the purchase cost of the goods sold:
CAMV = Purchases of goods – Change in inventory of goods = 180,000 – (30,000 – 40,000) = 180,000 – ( – 10,000) = 180,000 + 10,000 = 190,000.
The change in stock is equal to -10,000 since at the beginning of the period, the stock was 40,000, while at the end, it was only 30,000. We therefore "sold" €10,000 worth of goods during this period, which makes the calculation logical.
Next, we need to calculate the profit margin:
Gross profit = Revenue – Cost of goods sold = 300,000 – 190,000 = 110,000
And finally, we can calculate the added value:
Value Added (VA) = Gross Profit – Other External Expenses = 110,000 – 25,000 = €85,000
Value added of companies that produce
Industrial companies or those that produce goods and services (examples: a factory that produces socks or a bakery that produces bread) have a slightly different value addition formula:
VA = Production for the year – Consumption for the year from third parties
With :
- Production = Production sold + Production stored + Capitalized production
- Intermediate consumption (or consumption during the period from third parties) = Purchases of supplies – Change in supplies inventory + Other external expenses
Here, unlike a buy-sell company, we measure added value by valuing production (sold, stored and fixed assets), from which we subtract consumption from third parties for the given period, therefore finally the purchases of raw materials, from which we deduct the variation in stocks, and to which we add other external charges.
What is referred to as "supply purchases" in the formula are indeed purchases of raw materials not yet processed, and which are intended to produce the final good or service, such as flour in the case of a baker, or fabric for the sock factory.
Regarding inventory variation, we are trying to determine here what part of the stock has been "transformed", therefore "consumed"«. Therefore, if the stock increases (i.e., if ending stock > beginning stock, and the subtraction of the two is a positive value), This means that the remaining stock at the end of the fiscal year has not yet been consumed (i.e., it has not been transformed into a finished product). So it is necessary subtract it intermediate consumption, because the calculation of intermediate consumption aims to to estimate the value of the goods "consumed"«.
To make this even clearer, we could write the formula like this:
Intermediate consumption = Purchases of supplies – (Ending inventory – Beginning inventory) + Other external expenses
Therefore, if the change in stock is negative (the ending stock is less than the beginning stock), the change in stock will be added and not subtracted.
Finally, it is important to understand that in the case of an industrial company, which produces and processes, we take into account the value of production:
- the production sold: similar to sales for a buy-and-resell business; ;
- stockpiled production: because unlike a buy-sell company, here it is a question of valuing the stockpiled produced goods, that is to say the transformed goods which are in stock, not to be confused with the purchase cost of supplies (therefore the raw materials not yet transformed), which will be deducted from the calculation, as was the case for a buy-sell company; ;
- and capitalized production: for example, software developed and capitalized by the company which increases production and therefore the wealth of the company, in other words its added value.
📌 Numerical example (industrial company)
Let's take the example of a furniture factory:
- Revenue: €500,000
- Stockpiled production: + €20,000
- Capitalized production: 0
- Supply purchases: €200,000
- Change in raw material stocks: +15,000 (ending stock > initial stock)
- Other external expenses: €50,000
First, we need to calculate the value of the total production:
Total Production = Revenue + Stored Production + Capitalized Production = 500,000 + 20,000 + 0 = 520,000
Next, we need to calculate the expenses incurred during the fiscal year from third parties, in other words, the intermediate costs:
Intermediate consumption = Purchases of supplies ± Change in supplies inventory + Other external expenses = 200,000 – 15,000 + 50,000 = 235,000
So there was a trap here: the stock variation was stated in the problem as positive, because the stock increased (ending stock > beginning stock). Therefore, if it is positive, It is subtracted, not added, in the calculation., since :
Intermediate consumption = Purchases of supplies – (Positive change in inventory) + Other external expenses
If it had been negative, we would have had:
Intermediate consumption = Purchases of supplies – ( – Positive change in inventory) + Other external expenses = Purchases of supplies + Change in inventory + Other external expenses.
Logically speaking, if the change in inventory is positive, This means that the stock has increased between the beginning and the end of the exercise, and therefore that consumption (understand the "transformation of raw materials") from third parties decreased between the beginning and the end of the exercise, since the stock of raw materials has increased instead of being transformed.
In other words, a An increase in raw material stocks means that more has been bought than consumed/processed : on deduced therefore this increase in purchases of supplies for only count what has actually been consumed in the production.
Finally, all we have to do is calculate the added value:
VA = 520,000 – 235,000 = €285,000
Which therefore corresponds to total production minus intermediate consumption.
Case of mixed companies
A company can both purchase finished goods for resale and produce certain goods. In this case, it will be necessary to calculate the commercial value added and the industrial value added, then add the two together, without doubling the purchases, and deducting other external costs only once. An exercise dealing specifically with this case is available at the end of this course.
Summary of formulas
To help you remember the formulas and logic, here is a clear summary.
Trading company:
VA = CA − CAMV − Other external charges
= Revenue − [Purchases − (Ending Inventory − Beginning Inventory)] − Other external expenses
= Revenue − Purchases + (Ending Inventory − Beginning Inventory) − Other external expenses
= Revenue − Purchases + Change in inventory − Other external expenses
Industrial company:
VA = Production for the year − [Purchases − (Ending inventory − Beginning inventory) + Other external expenses]
= Production for the period − Purchases + (Ending inventory − Beginning inventory) − Other external expenses
= Production for the year − Purchases + Change in inventory − Other external expenses
For each case (trade or industrial), you can choose the version that suits you best between the one with parentheses and the one without parentheses.
Interpretation of added value
There are several ways to interpret added value, the simplest being to relate turnover to added value, in order to have a ratio that can be compared with a competitor for example, or with the average of the sector.
Value Added / Revenue = Gross wealth created per euro sold
In retail trade, for example, one can have a ratio of approximately 30%, whereas it will be approximately 70% in the service sector (because there are few purchases, and the share paid to employees is often larger).
Productivity can also be measured by calculating the ratio of added value to personnel costs:
VA / Staff
Distribution of added value
As we have said, added value is calculated very early in the SIG table, and EBITDA, operating profit or net profit come much later.
The added value is then distributed among various stakeholders. These include, among others, employees, the State, banking institutions, shareholders, and also the company itself, which can use part of the added value to self-finance or depreciate certain assets.
Eventually, Added value measures the wealth created by the company that will be redistributed to the various stakeholders.
The macroeconomic view of added value
We have seen so far what added value corresponds to at the microeconomic level, that is to say at the level of a company.
Value Added and GDP
In fact, the concept of added value goes far beyond corporate accounting, because The sum of all the added value (VA) of a country allows us to calculate the famous GDP., the Gross Domestic Product, which measures the wealth of a country.
At the national level, Added Value corresponds to the new wealth created by economic agents residing in a territory during a given period. It is calculated exactly as at the company level, namely:
Value Added (VA) = Production – Intermediate Consumption
But here, we add up the added value of all companies, from all sectors, which gives:
GDP = ∑ Value Added + taxes on products – subsidies.
GDP thus allows us to measure the wealth created within a country during a given period. The GDP formula includes taxes paid on products (which create wealth for the benefit of the state), and subtracts subsidies, i.e., public aid that artificially lowers the price of certain goods.
Choosing the sum of added values rather than the sum of sales figures is to avoid counting profits multiple times, which would lead to an inaccurate result. The aim is to prevent double or triple counting, so only sales production should be counted, deducting intermediate consumption. This allows us to "neutralize" supplier-related costs, which have their own added value.
The idea is to only count the value created at each stage of the production chain.
Example :
| Business | Activity | THAT | Intermediate consumption | GO |
|---|---|---|---|---|
| A | Wheat producer | 50 | 0 | 50 |
| B | Miller | 120 | 50 | 70 |
| C | Baker | 200 | 120 | 80 |
Total added value = 50 + 70 + 80 = 200 → This represents the wealth created. If we had added the sales figures, it would have given us 50 + 120 + 200 = 370 (which would have overestimated the actual production).
That is why GDP is based on the sum of value added.
Value Added Tax and Wealth Distribution
Added value represents the wealth created to be distributed among the various economic actors. It remunerates the factors of production—primarily labor and capital—but also the government (through taxes on production), banks (through interest), and the company itself, which retains a share as a profit margin. The distribution of this added value thus allows us to analyze the cost of labor, the profit margin, the level of debt, and the savings capacity of businesses.
Value Added and Productivity
VA also allows us to measure the overall productivity at the country level, a pillar of long-term growth.
Labor productivity = Value Added / Number of employees
This measure allows for comparison:
- Companies, as we saw earlier at the microeconomic level; ;
- Business sectors; ;
- Countries.
Furthermore, if value added increases while the number of wage earners and capital remain constant, this means that the country's economy is more efficient, which can explain potential growth and an improvement in living standards. This leads us to the next point.
Value Added Tax and Economic Development
Value added (VA) is a key indicator for:
- to analyze the economic structure of a country,
- follow the move upmarket (industry → high value-added services),
- to measure the impact of innovations,
- compare the dynamism between regions or states.
For example, countries like Japan, Germany, or South Korea are known for having sophisticated industries, which translates into high value added compared to other countries, and therefore high wages and GDP.
Conclusion on added value
In summary, the Added Value is:
✔ the cornerstone of measuring wealth (of a company, a sector, a country…); ;
✔ the core logic of GDP; ;
✔ the central indicator of income distribution; ;
✔ a major tool for economic analysis (productivity, competitiveness); ;
In corporate finance as in macroeconomics, understanding added value means understanding how wealth is created, transformed and then distributed.
Final case study (with solutions)
Let's take the case of a mixed company: production + buying and reselling
Data :
- Merchandise sales: €200,000
- Sales of finished products: €300,000
- Purchases of goods: €120,000
- Variation. Stock of goods: -€5,000
- Supply purchases: €150,000
- Variation. Stock supplies: +€10,000
- Stockpiled production: +€15,000
- Other external expenses: €60,000
Calculate the total added value of this company.
Answers
To simplify understanding, we will calculate, on the one hand, the commercial value added (VA), linked to the company's buying and reselling activity, and on the other hand, its industrial value added. Therefore, the "Other external expenses" item of €60,000 is a single item, which we will subtract at the end of the calculation to avoid double subtraction.
Calculation of commercial value added
Here we are told that the change in inventory is -€5,000. To be sure we understand, this means that the value of ending inventory minus beginning inventory is negative by €5,000 (the ending inventory is less than the beginning inventory by a value of €5,000). Therefore, to "value" this inventory that has been sold in the cost of goods sold, we must not subtract it but rather add it, and from a purely mathematical point of view, this is logical since A - (-B) = A + B.
SO :
Commercial value added = Sales – CAMV = Sales – Purchases of goods – Change in stock = 200,000 – 120,000 + 5,000 = 75,000 €.
Calculation of industrial value added
Industrial Value Added = Production (stored, capitalized, and sold) – Consumption from third parties = Production – (Purchases of supplies – Change in inventory of supplies) = 300,000 + 15,000 – (150,000 – 10,000) = €175,000
Calculation of Total Value Added
Total added value = Commercial added value + Industrial added value – Other external expenses = 175,000 + 75,000 – 60,000 = €190,000
This course is now complete. Feel free to ask any questions you may have or to show your appreciation to the author with a supportive comment!
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