Economic Value Added (EVA) is a financial tool used to calculate the dollar return on an investment after taxes, the cost of the capital used for the investment and the cost of assets used in the creation of the product. The after-tax profit minus the product of the cost of the assets times the weighted average expense of the capital used gives a dollar value. If the value is positive, the company made money. The simplicity of the system is one of the economic value added advantages.
The goal of every company is to have their business EVA in the positive and consequently grow wealth. In order to encourage profit-growing decisions by division managers, many companies turn to an economic value added analysis as a method of rewarding employees for positive company growth.
Consider the following as you use EVA in your company:
- Find out how to increase profits through an economic value added analysis.
- Determine whether it is profitable to acquire an existing business with EVA.
- Use an economic value added formula to gain a precise dollar growth and create a more precise method for bonuses.
Action Steps
The best contacts and resources to help you get it done
Identify the growth areas of your business from the use of economic value added calculation.
There are parts of the company that benefit from the application of the EVA formula. Start up areas and R&D are too long term to benefit from the application. Use it to compare growth when innovations that don't require large additional investments in equipment are in place. An EVA program identifies departments that require attention.
I recommend: Acorn Systems, Inc provides services that use EVA to analyze your business and find areas to improve your profit.
Vadim Kotelnikov offers computer programs with EVA templates.
Use the economic value added definition when acquiring businesses
The EVA formula works well when investigating acquisitions. It is often tough to figure out whether you can more efficiently operate the business you want to buy. You no longer have to use gut instinct to find if you can perform better after acquisition takes place. Use a computer program model and run your own numbers to find if your company should proceed with a buy out.
I recommend: Stern Stewart & Co., considered the flagship for the EVA model, provide advisors that aid in portfolio strategy.
Cash Focus Pty Limited provides Strategic Focus, software that uses EVA to that allows you to evaluate the profit or loss of a company.
Combine complementary methods of rewarding employees and measuring success
Some areas of the company fit beautifully into the EVA model and appropriate rewards gleaned from the economic value formula fit perfectly. Not all situations fit. To reward the extra effort of the innovative individual, encourage thinking outside the box and reward huge growth of smaller divisions you should consider alternatives to the EVA methods of compensation. Many times management overlooks new ideas because their main concern focuses too much on a good EVA report.
I recommend: The Waters Consulting Group, Inc. offers innovative ideas for management compensation.
D.G. McDermott Associates, LLC, can also help you determine the best compensation packages for your executives.
Tips & Tactics
Helpful advice for making the most of this Guide
- Use some of the information gleaned from EVA systems and combine it with common sense to find the best approach to make your financial decisions. No one method, whether intuitive or analytical, is appropriate for all situations.
- The economic value added model does not account for start up or future profit producing innovations that show no present increase in income.
The official source of Economic Value Added (EVA) is
the Economic Value Added (EVA) page at Business.com
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