Cockpit
Statements
Economic Value Added (EVA)
Economic Value Added (EVA) is a comprehensive financial metric because it entails all other financial metrics. This is one of the reasons why EVA is used vor value based incentives and indexed bonus targets. It is also the bases for indexing operating performance (see indexed strategy controlling).
Background
As we have seen in the metric wars, what is important about EVA, and perhaps what makes it more successful than other, similar metrics that came both before and after it, is not simply what it measures but how it is used. EVA requires that the cost of capital be assesed not only in valuations but also in measuring operating performance. Thus EVA makes possible the use of one metric for three related aspects of value-based performance management: capital allocation, performance assessment and incentive compensation. EVA is calculated as follows:
Definition
Economic Value Added (EVA) = Net Operating Profit after Taxes (NOPAT) - Capital Charge
Net Operating Profit after Taxes = Adjusted Net Operating Profit Before Taxes * (1 – tax rate)
Adjusted Net Operating Profit Before Taxes = Earnings Before Interest and Taxes (EBIT) - Adjustments
Capital Charge = Average Invested Capital * Cost of Capital
Invested Capital = Fixed Assets + Net Working Capital (NWC)
(Average Invested Capital is calculated from the beginning and end of the period.)
Net Working Capital = Current Assets - Cash and Cash Equivalents - Current Liabilities + Current Portion of Interest-Bearing Debt (in current assets)
Click here for more information about EVA Adjustments.
Click here for more information about Tax Treatment in EVA.
Click here for more information about calculating Cost of Capital.
Click here for more information about calculating Capital Charge.
Click here for the following section on EVA sub-metrics: the Value Driver Tree.
Click here for the final VBM section on value-based incentive compensation.
Applications
EVA can be split into its value sources by the value driver tree. To do this, the financial metrics have to be indexed by the method of indexing operating performance. The most important tools for this are Operating Rank, Operating Radar and Operating Contribution. These indexing tools split Economic Value Added into its components without external effects diluting operating performance measurement. A list of all indexing tools are here.
Literature
Recommended Readings: EVA by Stephen F. O'Byrne, Competitive Value Management, Making Bonus Systems Fair and Crisis Proof by Hermann J. Stern