Making EVA Work
One of the biggest problems with measuring the creation of value is that it's all over the place. Value comes from so many things: Customer service, efficient operations, great products, intellectual capital, etc. And if you expect to drive value from these sources, then you have to go way beyond financial measurements like EVA. That is why professionals like myself are big advocates of balanced scorecards and competitive intelligence . Since EVA is a "financial" type measurement and since value-creation has so many sources, EVA can't possibly be the sole driver behind value-creation.
Another problem with EVA is cost of capital is already recognized for highly leveraged companies. When debt is high, your cost of capital shows up on your Income Statement; i.e. outstanding debt requires interest payments. These payments show up on your Income Statement as interest expense. Also, your returns on assets are not easily measured. Suppose your organization is a knowledge based service company, than measuring the true returns on all assets becomes difficult. The "intellectual assets" within your organization are not measured and reported anywhere, but they can be the single most important asset you have for creating value.
Despite its limitations, EVA warrants serious consideration by many organizations; especially if your organization is relying on traditional financial measurements, such as ratio analysis. EVA reports the real economic profits of your organization. This is accomplished by forcing your organization to consider the entire cost of capital.
In order for EVA to work, you will need to consider the following:
- Build an EVA Model that fits your organization. For example, what adjustments are needed to capital? What business units are included in the calculations? What adjustments do you make to NOPAT (Net Operating Profits After Taxes)?
- Determine how you will apply EVA. What business units will you measure? What levels of management will be subject to EVA?
- Determine how you will implement EVA. How will EVA be reported? How do you get the organization to "buy in" on the idea of EVA? Who should receive training in EVA?
- Determine how EVA will impact your company. Who is the most responsible for generating EVA? Should you link compensation of key officers to EVA?
How EVA is introduced and implemented will be critical to its success. Remember EVA can create some uneasiness among your managers. Having top management as the champions of EVA will go a long way in making EVA work. The bottom line is simple: Management must increase shareholder wealth and EVA can represent a good metric to add to your existing financial measurements (Return on Gross Investment, Return on Equity, etc.). Everyone involved in Financial Management should be conversant with EVA.
Written by: Matt H. Evans, CPA, CMA, CFM | Email: firstname.lastname@example.org | Phone: 1-877-807-8756
Return to Listing of All Articles | The EVA Momentum Ratio |