Value Based Metrics
All Value Based performance metrics, also known as financial ratios or key performance indicators (KPIs), are fundamentally alike: they all recognize that value creation occurs only when a company's return on invested capital (ROIC) exceeds the weighted average cost of that capital (WACC), so they all attempt to measure how much that has or has not occurred.
Investors seek and reward this kind of value creation, translating to increased share price and enterprise value. VBM is essentially an attempt to manage operating performance from this capital markets perspective.
There are numerous competing Value Based metrics. Rather than choosing among them, Obermatt recognizes that different situations call for different metrics, and takes into account the pros and cons of each. Obermatt's innovative method of indexing operating performance can be applied equally well to all performance metrics, Value Based and traditional alike.
Some Value Based metrics are based on discounted cash flows (DCF) and calculated like internal rate of return (IRR). Their chief advantage is mitigating the effects of accrual accounting. The most popular of these is cash flow return on investment (CFROI). Others are based on investor expectations in the capital markets, such as market value added (MVA). But the most widely used and relevant Value Based metrics are those based on residual income, such as economic value added (EVA). Competition among these various metrics and their proponents has given rise to what has been called the metric wars.
EVA can be split apart, or disaggregated into component parts, essentially simpler financial ratios or KPIs. Sub-metrics of EVA are called value drivers because they combine to create or drive economic value. These value drivers are then also Value Based metrics, and they too can be measured, indexed and compared, especially for evaluation of business units and managers below the divisional level. Examples of these include measures of profit like net operating profit after taxes (NOPAT), measures of capital efficiency like return on net assets (RONA), margin measures like earnings before interest and taxes (EBIT Margin), and measures of growth. Disaggregated EVA sub-metrics are explained in detail and shown graphically in the Value Driver Tree.