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.
Economic value added formula and explanationThe 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.
Economic value added advantages improve business unitsEconomic 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.
Economic value added analysis increases long-term profitabilityThree 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.
- Due to the intricate nature of the EVA calculations and applications, consider consulting with a specialist before implementing this metric.