Accounting
Economic value added
Economic value added (EVA) takes into account a firm’s total invested capital when evaluating its financial performance.
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Economic value added vs Economic value added (EVA)
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Economic value added (EVA)
Helps managers answer: How well are we delivering value to our shareholders?
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Use EVA to assess the economic value created during a defined period by the capital invested in a firm or business unit.
Answer the key performance question: “How well are we delivering value to our shareholders?”
Extracted signals
Strengths, limits, and pitfalls.
Economic value added
- Start with a transparent approximation before adding dozens of adjustments. Reconcile NOPAT and invested capital to the financial statements, show the cost of capital assumption and focus managers on the operating drivers they can change.
- Define the operating boundary and period. Calculate NOPAT from operating profit after appropriate tax, calculate invested capital from the operating assets financed by debt and equity, estimate a weighted cost of capital and document every accounting adjustment. Use a consistent definition across periods and business units.
- Consider Cambrian Manufacturing, an oilfield equipment producer, using its 2013 results. Non interest bearing current liabilities include accounts payable, tax payable and similar operating liabilities. Additional assumptions are:
Watch for
- Do not judge a high growth investment from one period’s EVA alone. Current investment can depress the measure while creating future options. Use EVA to diagnose present economic performance, then assess growth opportunities with a multi period valuation and explicit risk analysis.
Economic value added (EVA)
- Treat EVA implementation as a management system change, not a new spreadsheet. Teach teams how operating choices affect NOPAT and capital, reconcile the measure to accounts and align incentives with sustained improvement rather than one period extraction.
Watch for
- Accounting adjustments can make EVA opaque, while a simplified version may omit meaningful economic differences. More importantly, a high hurdle can discourage uncertain but valuable growth. Pair EVA with explicit risk appetite and multi period strategic analysis.
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