EVA(TM) (economic value added) is a measure of financial performance that combines the old concept of residual income with principles of modern corporate finance--specifically, that all capital has a cost and that earning more than the cost of capital creates value for shareholders.
Companies that generate high EVA are top performers that are highly valued by shareholders.
To make EVA work for your company, take three steps and follow four rules that have worked for a wide range of companies during the past 10 years.
STEP 1: Understand EVA.
EVA is the dollar value created for investors over a set period of time, like a quarter or a year. The value added is any excess of after-tax operating profit minus all the costs of doing business, including the interest cost of debt and the opportunity cost of equity. in other words, EVA is after-tax operating profits, less a capital charge equal to the amount of profit needed to cover interest expense and provide an adequate return for equity investors.
What EVA is
First, EVA is the best way to integrate the often competing goals of growth and operating efficiency. As such, it is a better measure than earnings or return on net assets (RONA). Earnings growth creates size but does not always equate to share value growth because it may be achieved at excessive capital cost. RONA measures efficiency but not the magnitude of profits, as earnings does.
Low returning businesses may invest in projects that increase the average return on capital but earn less than the cost of capital. Likewise, high returning businesses may be incented to forego value-adding investments because they lower the average return. EVA combines the magnitude of an earnings measure with RONA's focus on efficiency.
Second, EVA measures the va ...