Economic Value Added (EVA) - How to Calculate Economic Viability of a Corporation

Economic Value Added is a performance ratio that determines the true economic profitability of a corporation because it factors in net operating income after taxes & interest minus the opportunity cost of capital deployed to earn that net operating income. In other words, Economic Value Added shows whether the financial performance of a company exceeds or is below the minimum required rate of return for shareholders or business lenders. Economic Value Added tells investors whether the amount of capital they have invested in to the business is generating them higher return than their minimum, or if it is better to invest the capital elsewhere. Here is how Economic Value Added (EVA) is used by financial analysts:

i) Economic Value Added is used as a performance evaluation tool of higher level managers, directors, VPs and CEOs of a corporation because the performance of the organization depends on the human resources deployed.

ii) Economic Value Added is used at sub-division level & entire organizational level of the business, unlike other methods such as Market Value Added that only focuses on the big picture of a corporation.

iii) Economic Value Added factors in to performance evaluation that the operating net income of a corporation must cover both operating costs of the organization as well as the capital costs (opportunity cost of capital). This is unlike other accounting methods such as EBIT or EBITDA or Net Income that look at total revenues generated by the business minus total expenses as a performance evaluation tool.

Economic Value Added: The Practitioner’s Guide to a Measurement and Management Framework: Craig Savarese

The shareholder value creation philosophy is a central element in many companies’ financial management practices. A widely adopted approach to measuring financial performance and managing for value creation is economic profit (economic value added). A deceptively simple concept, companies often are not prepared for the challenges and issues they need to consider when measuring economic profit, nor for how to incorporate it into financial management practices. This book addresses these challenges by: developing a framework for linking economic profit to shareholder value; explaining the issues relevant to developing a company-specific economic profit measure; and demonstrating how to incorporate economic profit into financial management practices. The book is about practical application - designed as a user’s guide - so that you can apply shareholder value principles and understand the implications for your business. It shows how economic profit links to shareholder value, and dispels commonly cited myths about adopting a shareholder value framework to drive a company’s financial management practices. It is aimed at financial managers and accounting professionals, managers, consultants and equity analysts who want to understand the application of shareholder value.