Economic Value Added (EVA) is a registered trademark of Stern Stewart & Co., so other companies may refer to this as "economic profit" to avoid trademark issues. The economic value added definition refers to a performance metric that measures the true economic profit of a company, which clearly communicates a shareholder’s investment value. Its basic premise is that a business must include operating costs and capital costs for a report of true profit. In the 1990s, large corporations sought better measures for internal wealth creation performance, so they turned to the EVA formula.

Many believe EVA is the most successful performance metric to find true economic profit. A strong financial theory and consistent valuation principles make it difficult to dismiss. Moreover, economic value added analysis is able to measure and track a company’s economic position over time, which reveals shifts in a company’s economic value. Will the economic value added model benefit your company? Take a look at these economic value added (EVA) basics:

1. Economic value added calculations need adjustments.

2. Long-term perspectives contribute to economic value added advantages.

3. Economic value added analysis yields results.

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Economic value added formula and explanation

The economic value added formula is: EBIT (Earnings Before Interest and Taxes) - Interest = Net Income - Cost of Equity Capital = EVA, and it appears to be a simple formula. But when people begins to implement the formula, they realize there are adjustments that need to happen. The Stern Stewart firm does not reveal all the nuances of their trademark formula to the public.

I recommend: Moneychimp provides an economic value added definition that includes the economic value added formula. For an economic value added example of adjustments needed to successfully apply EVA, review the explanation in Investopedia. A study posted on the Lehigh University website discusses the validity of accounting adjustments needed for EVA.

Economic value added advantages improve business units

Economic value analysis evaluates performance over time, which helps businesses determine which areas need increased asset flow to generate a positive return and increase shareholder value. The ability to focus on different divisions within a business helps build a strategic business unit. If profits are up, EVA increases and vice versa. Therefore, this metric pinpoints areas where financial performance is low, and you know exactly where to make corrections.

I recommend: Computerworld explains the objective of EVA, and Evanomics explains the use of EVA as a management tool.

Economic value added analysis increases long-term profitability

Three foundational ideas support EVA's formula: cash flow is a reliable value, some expenses are long-term investments, and a profitable company yields a return for shareholders. By using the information EVA provides, managers and shareholders receive productive information to help increase long-term profitability in a business unit.

I recommend: Look at 12manage for an explanation of economic value added that details benefits and specific usages. Value Based Management.net points out specific advantages of EVA when compared with other economic measures.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Due to the intricate nature of the EVA calculations and applications, consider consulting with a specialist before implementing this metric.

Economic Value Added (EVA) is a financial tool used to calculate the dollar return on an investment after taxes, the cost of the capital used for the investment and the cost of assets used in the creation of the product. The after-tax profit minus the product of the cost of the assets times the weighted average expense of the capital used gives a dollar value. If the value is positive, the company made money. The simplicity of the system is one of the economic value added advantages.

The goal of every company is to have their business EVA in the positive and consequently grow wealth. In order to encourage profit-growing decisions by division managers, many companies turn to an economic value added analysis as a method of rewarding employees for positive company growth.

Consider the following as you use EVA in your company:

1. Find out how to increase profits through an economic value added analysis.
2. Determine whether it is profitable to acquire an existing business with EVA.
3. Use an economic value added formula to gain a precise dollar growth and create a more precise method for bonuses.
   

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Identify the growth areas of your business from the use of economic value added calculation.

There are parts of the company that benefit from the application of the EVA formula. Start up areas and R&D are too long term to benefit from the application. Use it to compare growth when innovations that don't require large additional investments in equipment are in place. An EVA program identifies departments that require attention.

I recommend: Acorn Systems, Inc provides services that use EVA to analyze your business and find areas to improve your profit. Vadim Kotelnikov offers computer programs with EVA templates.

Use the economic value added definition when acquiring businesses

The EVA formula works well when investigating acquisitions. It is often tough to figure out whether you can more efficiently operate the business you want to buy. You no longer have to use gut instinct to find if you can perform better after acquisition takes place. Use a computer program model and run your own numbers to find if your company should proceed with a buy out.

I recommend: Stern Stewart & Co., considered the flagship for the EVA model, provide advisors that aid in portfolio strategy. Cash Focus Pty Limited provides Strategic Focus, software that uses EVA to that allows you to evaluate the profit or loss of a company.

Combine complementary methods of rewarding employees and measuring success

Some areas of the company fit beautifully into the EVA model and appropriate rewards gleaned from the economic value formula fit perfectly. Not all situations fit. To reward the extra effort of the innovative individual, encourage thinking outside the box and reward huge growth of smaller divisions you should consider alternatives to the EVA methods of compensation. Many times management overlooks new ideas because their main concern focuses too much on a good EVA report.

I recommend: The Waters Consulting Group, Inc. offers innovative ideas for management compensation. D.G. McDermott Associates, LLC, can also help you determine the best compensation packages for your executives.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Use some of the information gleaned from EVA systems and combine it with common sense to find the best approach to make your financial decisions. No one method, whether intuitive or analytical, is appropriate for all situations.
• •  The economic value added model does not account for start up or future profit producing innovations that show no present increase in income.

Economic Value Added (EVA), registered trademark of Stern Stewart & Co., is a performance metric used to measure the economic profit of a company. To measure the “true” profit of a company, calculate the operating profits (minus taxes) and subtract a reasonable amount for capitol employed. The resulting figures give shareholders an indication of their investment value.

Business EVA places value in capital as a tangible object. Therefore, understanding and effectively using economic value analysis encourages employees to seek investments with a viable rate of return. It is about increasing the spread between the return and cost of capital to reduce excess capital. Consider the following options to bring economic value added (EVA) education and training to your business:

1. Explore course offerings that feature the economic value added model.

2. Evaluate economic value added advantages with finance software.

3. Consider professional trainers to teach the economic value added formula for success.

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See the different courses offered for economic value added (EVA)

Offering courses to your employees to help them understand and utilize the benefits of EVA can bring a new focus to the bottom line of your business. With everyone looking for the same gain, employees and managers make choices that could lead to greater coherence and success. Pay attention to the level of the course offered and choose courses aligned with the employee's finance knowledge.

I recommend: Financial Management Training Center offers an online short course focused on value-based finance geared toward those with finance knowledge. Cortell International offers a few options for EVA courses ranging from two hours to one day. Shaws-Larson Associates has seminars and workbooks, and soon they will offer e-learning courses for EVA knowledge.

Examine economic value addition software options

Software programs vary slightly by details, but the focus is on improving your business financially. Often software programs use economic value added calculation to evaluate and pinpoint weaknesses and strengths. Software is useful for businesses and employees who have an understanding of finance and want help pulling all the calculations and evaluations together. Most programs streamline efforts with simple installation and data entry.

I recommend: For business and investment valuation software (including EVA), click on SoftwareFeast. For business valuation software utilizing EVA focused on analysis and improvement, see Cash Focus.

Talk with training professionals with an economic value added example of application

There are advantages to choosing a business that specializes in training employees. They offer on-site training, seminars, online classes and/or custom programs focused on your business needs. They strive to help employees understand and utilize the valuation system to the greatest benefit of your business.

I recommend: Value Creation Group explains EVA plus helps improve your business focus and processes. IDG Capital Group has options including on-site corporate workshops, seminars and online training open to finance and non-finance employees. For advanced seminar training, see the National Center for Continuing Education.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Seek assistance from professionals who are aware of economic value added disadvantages, while capitalizing on the advantages.

When sharing financial data about your company, you want to present it in the best light but also be as accurate as possible. Some companies prefer to use an economic value added analysis when measuring their operating performance. The fairly simple calculation allows companies to measure their economic success over time, factoring in both operating and capital costs. There are a number of key terms you'll need to understand in order to apply an economic value added analysis to your business.

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Economic value added

Economic value added, or EVA, is an equation used by businesses to measure their value. Put in simple terms, the calculation subtracts capital from after-tax earnings. An EVA calculation gives significance to a company's value over a specific period of time.

I recommend: For an economic value added example of adjustments needed to successfully apply EVA, review the explanation in Investopedia.

Earnings before interest and taxes

Earnings before interest and taxes, or EBIT, is also sometimes referred to as operating profit. EBIT is a measure of earning power and is watched closely by investors. It indicates a company's ability to pay off creditors.

I recommend: 12Manage gives another explanation of EBIT as well as a mathematical formula for how to make your calculation.

Net operating profit after taxes

To calculate earnings after taxes, you'll want to use the net operating profit after taxes, or NOPAT, equation. The NOPAT is a calculation showing operating efficiency, what a company would earn if there were no debt. NOPAT is commonly used for an economic value added calculation.

I recommend: Look through this chart further explaining the NOPAT mathematical equation from Balance Sheet Walk.

Net income

Sometimes referred to as the bottom line, net income can also be called earnings or net profit. Net income is whatever's left after subtracting the costs of doing business, such as depreciation, interest and taxes.

I recommend: BusinessTown offers a further look into business income statements.

Equity capital

When the owners of the business use their own funds to generate business income, that's referred to as equity capital.

I recommend: Check out this U.S. Small Business Administration article explaining equity capital.

Cash flow

The ebb and flow of cash in and out of a business represents business activity. For accounting purposes, cash flow is recorded at the beginning and end of a certain period of time to show a positive or negative balance. A company's cash flow isn't a very good measure of economic vitality, because many factors can net a positive or negative cash flow that can turn around with one transaction.

I recommend: Get the basic information about cash flow from Bankrate.