What is Economic Value Added ?
2934 reads · Last updated: December 5, 2024
Economic value added (EVA) is a measure of a company's financial performance based on the residual wealth calculated by deducting its cost of capital from its operating profit, adjusted for taxes on a cash basis. EVA can also be referred to as economic profit, as it attempts to capture the true economic profit of a company. This measure was devised by management consulting firm Stern Value Management, originally incorporated as Stern Stewart & Co.
Definition
Economic Value Added (EVA) is a financial performance metric that measures a company's net profit after deducting the cost of capital. It is calculated by subtracting the capital cost from the operating profit before tax and adjusting it to a cash-based after-tax amount. EVA is also known as economic profit because it attempts to capture the true economic profitability of a company.
Origin
The concept of EVA was introduced by the management consulting firm Stern Value Management, formerly known as Stern Stewart & Co. The metric gained popularity in the late 1980s and early 1990s, aiming to help companies better assess their financial performance and shareholder value creation.
Categories and Features
The main feature of EVA is its focus on the cost of capital, distinguishing it from traditional accounting profit metrics. EVA can be applied across different industries and company sizes, aiding management and investors in evaluating the effectiveness of investment projects. Its advantages include providing a more realistic view of profitability, but it is complex to calculate and requires accurate estimation of capital costs.
Case Studies
A typical case is The Coca-Cola Company, which adopted EVA in the 1990s as an internal performance evaluation tool. By focusing on EVA, Coca-Cola was able to better allocate resources and improve capital efficiency. Another example is DuPont, which used EVA to assess the performance of its various business units, thereby optimizing investment decisions.
Common Issues
Common issues investors face when using EVA include accurately estimating the cost of capital and understanding the complexity of EVA calculations. A frequent misconception is equating EVA with accounting profit, overlooking its adjustments for capital costs.
