economic value added
WHAT IS EVA? DEFINITION
Economic Value Added (EVA) is a financial performance method to calculate the true economic profit of a corporation. EVA can be calculated as Net Operating Profit After Tax minus a charge for the opportunity cost of the capital invested.
EVA ( © / ™ Stern Stewart & Co.) is an estimate of the amount that earnings differ from the required minimum rate of return (against comparable risk) for shareholders or lenders. The difference can be both a surplus or a shortage.
EVA COMPARED WITH MVA
Unlike Market-based measurements, such as MVA, EVA can be calculated for a divisional (Strategic Business Unit) level.
Unlike Equities measurements, EVA is a flow and can be used for performance evaluation over time.
EVA COMPARED WITH EBIT AND EPS
Unlike accounting profit, such as EBIT, Net Income and EPS, EVA is economic and is based on the idea that a company must cover both the operating costs AND the capital costs.
CALCULATION OF EVA. FORMULA
The basic formula for calculating EVA is:
Net Sales
- Operating Expenses
------------------------------------------------------
Operating Profit (EBIT)
- Taxes
------------------------------------------------------
Net Operating Profit After Tax (NOPAT)
- Capital Charges (Invested Capital x Cost of Capital)
------------------------------------------------------
Economic Value Added (EVA)
By taking all capital costs into account, including the cost of equity, EVA shows the financial amount of wealth a business has created or destroyed in a reporting period. In other words, EVA is profit in the way that shareholders define it. If the shareholders expect, say, a 10% return on their investment, they earn money only to the extent that their share of the NOPAT exceeds 10% of equity capital. Everything before that just builds up to the minimum acceptable compensation for investing in a risky enterprise.
USAGE OF THE EVA METHOD: ALIGNING DECISIONS WITH SHAREHOLDER WEALTH
EVA was developed to help managers to incorporate two basic principles of finance into their decision making:
1. The primary financial objective of any company should be to maximize the wealth of its shareholders.
2. The value of a company depends on the extent to which investors expect that future profits will differ from the cost of capital. By definition, a sustained increase in EVA will result in an increase in the market value of a company. This approach has proved valid and effective for many types of organizations. This is because the level of EVA isn't what really matters. Current performance already is reflected in share prices. It is the (continuous) improvement in EVA that brings (continuous) increases in shareholder wealth.
Some specific usages of EVA include:
• To set organizational goals.
• Performance measurement.
• Determining of bonuses.
• Communication with shareholders and investors.
• Motivation of managers.
• Capital budgeting.
• Corporate valuation.
• Analyzing equities.
Economic Value Added (EVA) is a financial performance method to calculate the true economic profit of a corporation. EVA can be calculated as Net Operating Profit After Tax minus a charge for the opportunity cost of the capital invested.
EVA ( © / ™ Stern Stewart & Co.) is an estimate of the amount that earnings differ from the required minimum rate of return (against comparable risk) for shareholders or lenders. The difference can be both a surplus or a shortage.
EVA COMPARED WITH MVA
Unlike Market-based measurements, such as MVA, EVA can be calculated for a divisional (Strategic Business Unit) level.
Unlike Equities measurements, EVA is a flow and can be used for performance evaluation over time.
EVA COMPARED WITH EBIT AND EPS
Unlike accounting profit, such as EBIT, Net Income and EPS, EVA is economic and is based on the idea that a company must cover both the operating costs AND the capital costs.
CALCULATION OF EVA. FORMULA
The basic formula for calculating EVA is:
Net Sales
- Operating Expenses
------------------------------------------------------
Operating Profit (EBIT)
- Taxes
------------------------------------------------------
Net Operating Profit After Tax (NOPAT)
- Capital Charges (Invested Capital x Cost of Capital)
------------------------------------------------------
Economic Value Added (EVA)
By taking all capital costs into account, including the cost of equity, EVA shows the financial amount of wealth a business has created or destroyed in a reporting period. In other words, EVA is profit in the way that shareholders define it. If the shareholders expect, say, a 10% return on their investment, they earn money only to the extent that their share of the NOPAT exceeds 10% of equity capital. Everything before that just builds up to the minimum acceptable compensation for investing in a risky enterprise.
USAGE OF THE EVA METHOD: ALIGNING DECISIONS WITH SHAREHOLDER WEALTH
EVA was developed to help managers to incorporate two basic principles of finance into their decision making:
1. The primary financial objective of any company should be to maximize the wealth of its shareholders.
2. The value of a company depends on the extent to which investors expect that future profits will differ from the cost of capital. By definition, a sustained increase in EVA will result in an increase in the market value of a company. This approach has proved valid and effective for many types of organizations. This is because the level of EVA isn't what really matters. Current performance already is reflected in share prices. It is the (continuous) improvement in EVA that brings (continuous) increases in shareholder wealth.
Some specific usages of EVA include:
• To set organizational goals.
• Performance measurement.
• Determining of bonuses.
• Communication with shareholders and investors.
• Motivation of managers.
• Capital budgeting.
• Corporate valuation.
• Analyzing equities.
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