EVA (Economic Value Added)- economic profit is one of the most important indicators in assessing the production efficiency of a company. Reflects economic value added. EVA indicator usually priced at one reporting period(quarter, year, less often - month) and reflects economic profit after paying taxes, interest on attracted and equity capital (invested during the period).

EVA calculation algorithm

Net operating profit NOPAT is reduced by the amount of payment for the use of own and attracted (borrowed) capital.
Economic sense of EVA is that the enterprise must not only ensure break-even operation (more about calculating the break-even point), including return on investment, but also create additional value (the classic school calls it added value).

Methods and formulas for calculating EVA

In practice, there are many ways to calculate EVA, here are some of them:

EVA = (RENT-WACC) * SOS = NOPAT - WACC*SOS
Where,
RENT - return on investment, calculated RENT = NOPAT/SOS;
WACC - weighted average cost of capital;
SOS - own working capital(capital employed) = total assets - current liabilities.

EVA = NOPLAT - NZK = NOPLAT - IC * WACC
Where,
NOPLAT - net operating profit indicator;
NZK - normal capital costs;
IC - volume of investment.

In the reports of the largest Russian companies, a formula that takes into account ROCE indicator- return on invested capital. EVA calculation logic in this case is simple - economic profit arises only if the company managed to achieve a return on invested capital exceeding the weighted average cost of capital.

EVA = (ROCE - WACC) * IC = SPREAD * IC
Where,
SPREAD - the difference between ROCE and WACC.
If SPREAD > 0, then the company's profitability exceeds the predicted profitability of investors (initially set based on the cost of capital WACC).

EVA formula by B. Stewart

Without exception, all formulas and methods for calculating economic added value are based on B. Stewart's formula, which looks like this:

EVA = NOPAT - WACC * IC

In order to maximize the accuracy of the EVA calculation, Stewart proposed using 164 indicator adjustments, but nevertheless, to simplify management reporting, he used only a number of the most significant adjustments.
Model EVA is one of the most common models in assessing the value of an enterprise. It is the assessment of operating activities over a significant period of time that can give the most accurate result in assessing the company. It is assumed that a normative target value will be set to monitor the activities of all departments of the enterprise. EVA assessment is transparent both for the company's management and for its shareholders and creditors. Analysis of the indicator of economic added value by division can identify the most valuable and profitable products for the company, on which it is worth focusing attention and into which to direct the vast majority of investment funds.

Disadvantages of the EVA method and model

The main disadvantage of the method for assessing economic added value is the calculation using many possible formulas (given above). Due to the difference in calculation methods, we cannot objectively compare two companies in terms of EVA without knowing which calculation method was used to evaluate the indicator in each company.

Stages of implementing the EVA management model in an enterprise

Stage 1. The first step is to draw up a long-term development strategy for the company. Alternative strategies are analyzed and the most attractive and appropriate to the market situation is selected.
Stage 2. Introducing managers to EVA ideology. The vector is set on long-term goals, on the growth of economic added value. The rational use of resources in areas of activity is monitored.
In general, we need to strive for profitability ROCE exceeded the cost WACC.
Stage 3. Development of a unified methodology for goal setting and evaluation of the result according to EVA. Formation of basic models and accounting of indicators involved in the formation of economic added value. Methods for calculating all indicators that have many calculation formulas are determined.
Stage 4. Implementation into operational activities. EVA is included in the list of indicators that are assessed in the analysis of the company's operating activities.

R.A. Andrutsky Chief economist for business planning of NII TK LLP, Master of Economics
Journal "Accounting and Finance", No. 7 for 2008

Balance (‘000 cu)

Assets		Liability and capital
Current assets		Short-term liabilities
Cash and cash equivalents		Short-term financial liabilities
Short-term receivables		Short-term accounts payable
		Other current liabilities
Other current assets		long term duties
Long-term assets	2 833 000	Long-term financial liabilities
Long-term accounts receivable		Capital	1 723 000
Fixed assets		Issued capital
Intangible assets
Other long-term assets		Retained income (uncovered loss)
Balance	3 198 000	Balance	3 198 000

Profit and loss statement (‘000 cu)

Sales income
Cost of sales, incl.
Operating expenses
Depreciation
Administrative expenses
Marketing expenses
Profit from operating activities
Interest expenses
Profit (loss) before tax
CIT expenses, 30%
Total profit (loss) for the period

In the first step, we will determine NOPAT using data from the Income Statement. Then, in subsequent calculations, we use the balance information. In the second step we calculate ACE. To do this, the company's interest liabilities are added to the capital. Next, WACC is determined taking into account the tax shield on debt capital. And in the fourth step we calculate EVA.

1. NOPAT = 535,000 − 123,000 = 412,000 USD

2. ACE = 1,723,000 + 850,000 + 275,000 = 2,848,000 USD

3. WACC = 0.37 × 12% + 0.63 × 14.7% × (1 − 0.3) = 11%

4. EVA = 412,000 − 11% × 2,848,000 = $100,903

The resulting EVA indicator > 0, that is, the company creates added economic value shareholders.

Conclusions.

EVA strategy is one of the most popular initiatives in the field of value-based management, which allows you to radically reconsider the company's goals and values. The company must be fairly assessed by both potential investors, clients, partners, and owners, so EVA retains its place in the system of key indicators and, in addition to other functions discussed in this article, constantly reminds of the role of the company's owners. EVA in the management system allows for strategic and operational planning, measurement and control of results. I think that for a company aimed at creating value for shareholders, the relevant question will not be “to use or not to use EVA in management?”, but the question “how and to what extent to use EVA?”

1 The data is fictitious.

2 The example shows a simplified version of the definition of ACE; in practice, it is recommended to take the average values ​​of the elements of this indicator at the beginning and end of the reporting period.

Federal State Educational Institution of Higher Professional Education Financial Academy under the Government of the Russian Federation (FINACADEMY)

Department of Valuation and Property Management

Abstract on the topic:

"Economic added value

( EVA )»

Performed : student of FM group 4-2

Kalabashkina E.

Scientific supervisor: Tulina Yu.S.

Moscow

Introduction

In the 1970s - 1980s in companies developed countries The question arose about developing a new financial management mechanism. This was explained by the fact that the methods of assessing the company’s activities that existed before that time could no longer meet the growing requirements of managers, since they did not allow assessing the company’s activities in terms of long term. In addition, investors began to demand from company management a constant increase in the value of the company - an indicator reflecting the level of well-being of shareholders.

The concept of economic value added (EVA™), developed in the USA in the 80s of the last century, solved the problems posed. Based on the principle of economic profit, the EVA indicator could be used to determine value, as well as to characterize the long-term activities of the company.

This concept quickly began to be used by leading American companies, such as Coca-Cola, General Electric. Soon, their experience began to be adopted by companies (including small ones) in other countries.

Russia currently has the opportunity to borrow the most advanced foreign technologies and business methods, which always gives the “catching up” country an advantage over the “overtaking” one. In this regard, it is important for domestic companies to immediately implement and use advanced management mechanisms. The use of the concept of economic added value, which is one of the advanced concepts of financial management, will allow domestic firms to increase operational efficiency and reduce the gap with foreign competitors.

Despite the positive experience of use abroad, the concept of economic added value is currently little used Russian companies. The main reason for this is the complexity of its application “in its pure form” in the Russian economy. Accordingly, determining the possibility and developing mechanisms for using the concept of economic added value in the financial management of Russian companies is an urgent task of financial science.

The object of this study acts as a process of financial management of a company.

Subject of study– company financial management mechanisms based on the concept of economic added value.

Theoretical and methodological basis of the study compiled the work, first of all, foreign specialists in area corporate finance, cost assessment, company value management and, in fact, the EVA concept.

Among classical works The theory of finance should highlight the works of F. Modigliani, M. Miller, E. Fama and W. Sharp, S. Ross, S. Pratt.

Of the works devoted to the concept of EVA, first of all, it should be noted the work of its author B. Stewart “The Quest For Value: a Guide for Senior Managers”, as well as the book by D. Young and S. O’Byrne “EVA and Value-Based Management: a Practical Guide to Implementation". Among the empirical works that examine the results of implementing EVA in practice, it is worth highlighting the works of S. Weaver, G. Biddle and R. Bowen.

In the 70-90s, two concepts for assessing the cost and efficiency of enterprises appeared, among which the most popular in last years are balanced scorecard(BSC) and economic added value(EVA).

Development of a paradigm for determining the cost and efficiency of a company

1920s	1970s	1980s	1990s
· Du Pont Model; Return on Investment (ROI)	· Net earnings per share (EPS); · Ratio of share price and net profit (P/E)	· Ratio of market and book value of shares (M/B); · Profitability share capital(ROE); · Return on net assets (RONA); · Cash flow(Cash Flow)	· Economic value added (EVA); · Earnings before interest, taxes and dividends (EBITDA); · Market value added (MVA); · Balanced Scorecard (BSC); · Total shareholder return (TSR); Cash flow return on invested capital (CFROI)

2. Economic value added (EVA): essence, formula for calculation, meaning.

In Russian-language economic literature the concept of EVA is considered only in individual works, almost exclusively in translations. EVA is important financial indicator– relatively recently (in the early 90s of the last century) it began to be actively used by many corporations in the USA and some other countries (for example, let’s name AT&T, QuarkerOats, Briggs & Stratton, Coca-Cola).

Economic value added ( EVA) represents the enterprise's profit from ordinary activities minus taxes, reduced by the amount of payment for all capital invested in the enterprise.

The indicator is used to assess the efficiency of an enterprise from the position of its owners, who believe that the activity of the enterprise has a positive result for them if the enterprise managed to earn more than the return on alternative investments. This explains the fact that when calculating EVA, not only the fee for using borrowed funds, but also equity capital is deducted from the amount of profit. It can be argued that this approach to a greater extent is economic rather than accounting.

The author of the concept of “economic added value” D.B. Stewart defined this indicator as the difference between net operating income and cost of capital, i.e. E V.A. allows you to estimate the real economic profit at the required minimum rate of return.

Economic value added is an indicator of the annual profitability of an enterprise, which primarily shows shareholders whether the enterprise has managed to create additional value. EVA can also serve as a goal for senior management and be used in a motivation system.

Logic of the indicator EVA is as follows: Net operating income after taxes is the income received after subtracting expenses and depreciation. Part of this income goes to pay the costs of using resources (expressed in the costs of equity and borrowed capital), and the other part is the created value, which is measured by E V A. This concept is based on the fact that it is not enough for a company to have a positive financial results or an acceptable level of income per share, any economic entity in the course of its economic life must reach a level of development at which it is possible to create new value. And it is created only when the company receives a return on invested capital that exceeds the cost of raising capital.

Economic added value is calculated using the formula:

EVA = NOPAT - Capital = NOPAT - WACC * C.E.

EVA ( Economic Value Added ) - economic added value.

NOPAT ( Net Operating Profit After Tax ) - net profit, received after paying income tax and minus the amount of interest paid for the use of borrowed capital. That is, this is net profit according to data financial statements(according to the Profit and Loss Statement) taking into account the necessary adjustments.

Capital ( Cost Of Capital ) - the total cost of capital of the company (consists of equity and debt capital, measured in absolute units).

WACC ( Weight Average Cost Of Capital ) - weighted average cost of capital (measured in relative values- in %), this is the cost of total capital (equity and debt).

C.E. ( Capital Employed ) - invested capital. Represents capital, determined taking into account the cost of resources not included in the balance sheet. Calculated by adjusting financial reporting data.

Cost of invested capital ( C.E. ) is calculated using the formula:

C.E. = T.A. – NP , Where

T.A. ( Total Assets ) - total assets (balance sheet),

NP ( Non Percent Liabilities ) - non-interest-bearing current liabilities (on the balance sheet), that is, accounts payable to suppliers, the budget, advances received, other accounts payable.

Weighted average cost of capital ( WACC ) is calculated using the formula:

WACC = Ks *Ws+ Kd * Wd * (1 - T), Where

Ks- price equity (%),

Ws- share of equity capital (in%) – on the balance sheet,

Kd- cost of borrowed capital (%),

Wd- share of borrowed capital (in%) - on the balance sheet,

T- income tax rate (in%)

Cost of equity ( Ks ) is calculated using the method CAPM :

Ks = R + b * (Rm - R) + x + y + f, Where

R- risk-free rate of return (for example, deposit rate) (%),

Rm- average return on shares on the stock market (%),

b- beta coefficient, which measures the level of risk,

x- premium for risks associated with insufficient solvency (%),

y- premium for the risks of a closed company associated with the inaccessibility of information about financial condition and management decisions (%),

f- country risk premium (%).

Cost of borrowed capital ( Kd ) is calculated using the formula:

Kd = r * (1 - T ), Where

r- annual interest rate for the use of borrowed capital,

T- income tax rate.

From the formula for economic added value we can derive relative indicator "Return on invested capital" ( Return on Capital Employed , ROCE ). The economic meaning of this indicator is that economic value added (EVA) arises in the company if, over a given period of time, it was possible to earn a return on invested capital (ROCE) higher than the investor's rate of return (WACC).

Investors (owners, shareholders) will not consider themselves satisfied if the return on their capital earned in the company does not reach the barrier rate of return they set.

This principle of forming the value of a company is expressed in the indicator of economic value added (EVA):

EVA = Spread * CE = (ROCE - WACC) * CE

Spread– yield spread (difference) between the return on invested capital and the weighted average cost of capital. The spread represents economic value added in relative terms (in %).

Spread = ROCE – WACC

If Spread is positive, then the company has earned a return that exceeds the return required by investors. In this case, the return on capital invested in the company is higher than the alternative return for the investor, because all alternatives are assessed and taken into account in the weighted average cost of capital (WACC) indicator. Consequently, the final result - the emergence of economic added value means an increase in the value of capital for a given period.

ROCE (Return on Capital Employed)- Return on invested capital:

ROCE = NOPAT / CE

Essence EVA is manifested in the fact that this indicator reflects the addition of value to market value enterprises and assessing the effectiveness of the enterprise by determining how this enterprise is valued by the market.

Market value of the enterprise = net assets (at book value) + EVA future periods, reduced to the present time

The EVA value determines the behavior of the owners of the enterprise in relation to investing in this enterprise:

1. EVA = 0 , i.e. WACC= ROI and the market value of the enterprise is equal to the book value of net assets. In this case, the owner's market gain from investing in this enterprise is zero, so he gains equally by continuing operations in this enterprise or investing in bank deposits.

2. EVA >0 means an increase in the market value of the enterprise over the book value of net assets, which stimulates owners to further invest funds in the enterprise.

3. EVA <0 leads to a decrease in the market value of the enterprise. In this case, the owners lose the capital invested in the enterprise due to the loss of alternative profitability.

From the relationship between the market value of the enterprise and the EVA values, it follows that the enterprise must plan future EVA values ​​to guide the actions of the owners in investing their funds.

The expectation of future EVA values ​​has a significant impact on the growth of the company's share price. If expectations are inconsistent, the stock price will fluctuate, and in the short term it will not be possible to draw a clear relationship between EVA values ​​and the company's stock price. Therefore, the task of planning profit, and with it planning the structure and price of capital, is the primary task of enterprise management.

The EVA concept is often used by Western companies as a more advanced tool for measuring the performance of departments than net profit. This choice is explained by the fact that EVA evaluates not only the final result, but also the price at which it was obtained (i.e., how much capital was used and at what price).

3. Ways to increase EVA:

1. Increase in profit while using the same amount of capital;

2. Reducing the amount of capital used while maintaining profits at the same level;

3. Reducing the cost of raising capital.

Separately, we can highlight the reduction of taxes and other obligatory payments within the framework of tax planning, using various schemes allowed by the legislation of the Russian Federation.

The identified ways to increase EVA are implemented in specific activities carried out by enterprises. If the EVA indicator is chosen by an enterprise as a criterion for assessing the effectiveness of its activities, then the task is to increase the value of this criterion. Such an increase occurs both as part of the reorganization of the enterprise and as part of current management activities.

Activities aimed at increasing the efficiency of the enterprise

Performance evaluation criterion Goal of change Main types of organizational changes EVA growth 1. Increase in profit while using the same amount of capital a) Development of new types of products (works, services); b) Development of new markets (new market segments); c) Development of more profitable adjacent links in the production and technological chain. 2. Reducing the amount of capital used while maintaining profits at the same level Liquidation of unprofitable or insufficiently profitable areas of activity (including liquidation of an enterprise) 3. Reducing the cost of raising capital Changing the capital structure of an enterprise

In general, to summarize, we can outline the role played by the indicator of economic added value in assessing the efficiency of an enterprise:

· EVA acts as a tool that allows you to measure the actual profitability of an enterprise, as well as manage it from the position of its owners;

· EVA is also a tool to show plant managers. how they might affect profitability;

· EVA reflects an alternative approach to the concept of profitability (a transition from calculating return on invested capital (ROI), measured in percentage terms, to calculating economic value added (EVA), measured in monetary terms);

· EVA acts as a tool for motivating enterprise managers;

· EVA improves profitability primarily by improving the use of capital rather than by focusing its efforts on reducing the cost of capital.

Thus, it can be assumed that the use of the EVA indicator in management accounting will help improve the quality of assessing the performance of Russian enterprises.

The indicator of added economic profit can be increased by:

1. increasing the return on existing capital, which can be achieved by increasing prices or margins, increasing volumes or reducing costs;

2. growth in profitability, which can be achieved by investing capital in projects with growing profits and adequate expenditure of additional capital, while investments in working capital and production capacity may be required in order to increase sales volumes, promote new products or develop new markets;

3. optimization of investments, which can be achieved through rationalization, liquidation or reduction of investments in operations that cannot provide a return on the cost of capital;

4. optimizing the cost of capital, which can be achieved by reducing capital costs, while maintaining the financial flexibility necessary to implement the strategy of using debt, management risk and other financial instruments.

Thus, you can increase added economic profit in three ways - increase profit using the same amount of capital; reduce the amount of capital used while maintaining profits at the same level; and reduce capital raising costs.

The concept of managing the value of a company based on the economic value added method suggests using the economic value added (EVA) indicator as the main criterion for assessing the company’s activities.

The goal of value management is to maximize the value of the company through the continuous growth of economic value added (EVA). And the way to manage value is to manage the factors that influence the value of the company.

A company's performance is influenced by a huge number of different factors. They can be classified as external and internal environmental factors (that is, macro- and microeconomic factors). The former influence the company's performance from the outside, the latter from the inside.

Internal factors affecting the cost may include:

· Growth rate of sales of company products/services

· Growth rates of main items of the Balance Sheet and Profit and Loss Statement

Net profit growth rate

· Rate of return of the owner (shareholder, investor)

· Other factors

External factors influencing the cost may include:

· Level of investment, marketing, financial, production and organizational risks of the company

· Change in the cost of borrowed capital (interest rate on loans)

· Changes in tax rates

Economic value added is an important economic indicator that characterizes the efficiency of using the capital of an enterprise, adding to the market value of the enterprise. Economic value added is real economic income, calculated based on the difference between the profit earned and the profit required by the owner, determined using the cash method of accounting for income and expenses.

Economic value added, economic profit and other indicators of residual profit have clear advantages over accounting profit as a criterion for assessing performance.

EVA serves as a constant reminder to managers: invest if and only if the return on investment is sufficient to offset the cost of capital. Managers accustomed to focusing on accounting profits or profit growth find this “signal” relatively easy to pick up. The EVA criterion can be used to support incentive and reward systems suitable for all levels of the organization, right down to the very bottom. For senior management, such systems can replace careful monitoring. With EVA-based compensation systems, management will no longer have to tell lower-level managers not to waste capital and then check whether they follow this order. Using EVA involves delegating authority and responsibility.

EVA gives managers visibility into their cost of capital. A plant manager can improve EVA in two ways:

1) increasing profits;

2) reducing the capital involved.

Because of this, the manager has an incentive to get rid of underutilized assets or transfer them to other hands. Working capital may also decrease.

The indicator of economic added value has a number of disadvantages: this indicator does not reflect the forecast of future cash flows and, therefore, the present value. In contrast, EVA is determined only by the current year's profit. Accordingly, it encourages managers to pursue projects with quick returns and discourages projects that begin to pay off later. Similar problems arise when launching a new risky enterprise, when huge capital investments are required, and profits in the first years are low or even negative. Moreover, this does not equate to a negative net present value, since later profits and cash flow will increase significantly. But at the initial stage, economic value added will be negative, even if the project is predicted to have a high positive net present value by all parameters.

Among the disadvantages of the concept are the following:

· the EVA indicator does not take into account differences in the size of the companies under study;

· EVA calculation is based on accounting indicators;

· the EVA indicator does not reflect the causes of possible problems in the company's activities.

The ability to calculate EVA not only when evaluating an investment project, but also as an indicator of a company’s performance for any period is its significant advantage compared to traditional indicators such as income or profitability. This advantage is due to the fact that the EVA concept is based on an integrated approach to three main areas of management:

· preparation of capital budget;

· assessment of the performance of departments or the company as a whole;

· development of an optimal fair bonus system for management.

The advantages of applying the concept in the first two areas are associated with an adequate and non-labor-intensive determination of the degree to which a division, firm or individual project has achieved the goal of increasing market value.

Unfortunately, most companies use traditional performance indicators, namely: profit and marginal profit, sales volumes, income, etc., which can show a distorted picture of the company’s state from the perspective of its “health” over a long period.

Conclusion

Regardless of the size of the company, continued creation of value for investors is the main goal of all business organizations, therefore, an objective assessment of the effectiveness of investments is no less important.

Today, EVA is the most accurate way to assess a company's performance. It is even more accurate than traditional profit measures because it includes the present value of capital.

In most cases, the use of EVA is the first step towards the implementation of a system of continuous improvements and the subsequent use of modern management tools.

Bibliography

1. Osipov M.A. Using the concept of economic added value to improve efficiency and measure company performance // History of management thought and business. VI International Conference “Problems of Measurement in Organizational Management”. Moscow, June 23-25, 2007 / Ed. IN AND. Marsheva, I.P. Ponomareva. – M.: MAKS Press, 2007. – P. 98-103.

2. Osipov M.A. Modern mechanisms of enterprise management and measurement of its activities // Finance: Collection of articles. - M.: Sputnik + Company, 2008. – P. 95-126.

3. http://www.cfin.ru/management/controlling/evalution.shtmlEVAlution of the balanced scorecard Konstantin Redchenko, Ph.D., Associate Professor, Lviv Commercial Academy

4. http://1fin.ru/?id=185

L.I. Schneider Kuban State University

5. Damodaran A. Investment assessment. Tools and techniques for assessing any assets / A. Damodaran: Trans. from English M.: Alpina Business Books, 2005.

6. Teplova T.V. Investment levers for maximizing company value. Practice of Russian enterprises. M: Vershina, 2007.

7. Copeland T., Murrin J. Company value: assessment and management. M.: Olympus-business. 1999.

8. D. Young, S. O'Byrne. EVA and Value Based Management. A Practical Guide to Implementation - McGraw-Hill – 2000, Chapter 1, 2, 6, 9

EVA™ is a registered trademark of the consulting company SternStewart & Co. Next is EVA.

Stewart B. The Quest For Value: a Guide for Senior Managers. - New York: HarperCollins Publishers, 1991.

Http://www.cfin.ru/management/controlling/evalution.shtml

EVAlution of the balanced scorecard Konstantin Redchenko, Ph.D., Associate Professor, Lviv Commercial Academy

Http://www.finanalis.ru/litra/324/2293.html Economic added value Elena Larionova Consultant for financial analysis and planning at CG "Voronov and Maksimov", lecturer at the Faculty of Economics of St. Petersburg State University http :// www . vmgroup . ru /

Http://1fin.ru/?id=185L.I. Schneider Kuban State University

The EVA (economic value added) indicator proposed by the consulting company Stern-Stewart is an assessment of the economic profit of the organization. Essentially, it is the profit earned by the organization reduced by the cost of capital.

The key question this metric helps answer is how successful are we in delivering returns to our shareholders?

EVA - Economic Value Added

This indicator is used as a mechanism for internally managing a company's operating activities and investment decisions to ensure that investors meet or exceed investor expectations.

EVA is a measure of economic returns that exceed investor expectations and, barring accounting anomalies, serves to directly compare companies with the same risk profile. Examples of anomalies include R&D and training costs; According to the theory, these are investments that should be considered as such.

The ability to accurately compare performance is based on the cost of capital. According to the EVA approach, organizations earn profits only when they include the cost of capital in the calculation of financial performance. Capital is never free. There is an opportunity cost of capital, i.e. investors can invest their funds in different instruments (government bonds, banks, etc.). To get the actual profitability of a business, it is important to subtract the cost of capital from profits. Capital is accounted for both debit and credit. Capital is a measure of all funds invested in a company throughout its existence, regardless of their source.

EVA is also actively used to set the size of incentive bonuses for managers. What's particularly interesting in our post-crisis world is that the bonus structure encourages a careful balance between short-term and long-term financial performance (which protects the interests of shareholders with long-term investments in the company). Moreover, the approach to calculating bonuses is being improved so that managers share the “sorrow and joy” of investors. As the CEO of one organization that implemented an EVA bonus approach said, “We want to make sure that the people who work for [the company] have the same goals as the people who invest in the company.”

The incentive payment model is based on a bonus bank. The way the bonus pot works is that each year the bonus amount is determined based on the EVA compared to its target value and this bonus is then placed into the bonus pot. Typically, a third of this bonus is paid for the current year, and the remainder is retained as a payment for the risk of falling EVA in subsequent years.

It must be emphasized that employees should be rewarded for the results of the previous year, this will contribute to improvements in subsequent years. It is also important to note that bonuses are not necessarily paid when EVA is positive, as the trend may be downward. Conversely, if a division started the year with a significantly negative EVA but showed significant positive growth during the year, then bonuses may be paid even if the final EVA remains in the negative.

How to take measurements

Information collection method

The data is taken directly from the income statement and takes into account the cost of capital charge.

Formula

Economic Value Added = Net Operating Income After Taxes - (Cost of Capital × Capital Employed).

EVA = NOP AT - (C × K),

where NOPAT is net operating profit after taxes;
C is the weighted average cost of capital (WACC), which is the average rate at which the company expects to raise funds from shareholders to finance its assets; K - used economic capital.
The cost of capital in organizations is measured using the CAPM (Capital Asset Pricing Model) method. The company's nominal cost of capital is calculated as the sum of the basic risk-free rate of return and the β-coefficient of the asset's sensitivity to changes in market returns. Thus, the equity rate is the expected return of investors buying shares of the company. It is expressed as follows: Investors' expected return (future) = Risk-free rate of return (future) + company's β (relative measure of volatility) × Equity risk premium (history).
The equity risk premium represents the return above the risk-free rate of return that investors expect from investing in risky assets. So, if the risk-free rate of return is 7%, β is 1.1, and the implied risk premium is 4%, then the company's cost of capital will be: 7% + (1.1 × 4%) = 11.4%.
The cost of borrowing is the rate of return at which a lender provides borrowed funds. To determine this rate, it is necessary to calculate the profit. This is usually done using discounted cash flow analysis. The cost of borrowing must be calculated after taxes as follows: Cost of borrowing after taxes = Cost of borrowing before taxes x (100 - Marginal Tax Rate).

Measurement frequency

Economic value added is calculated on a monthly basis. The weighted average cost of capital is determined on an annual basis.

The source of information is the balance sheet data.

Collecting data to calculate economic value added requires somewhat more effort than for other financial indicators. The more accessible the required data, the cheaper and faster the EVA calculation will be. If the data is available, then all you need to do is create a new formula in the accounting system. However, if important data is lost, restoring it can be very costly.

Target values

Performance in terms of economic value added can be assessed by comparison with the performance of organizations with a similar risk profile.

Example. Consider the example of a company that designs, manufactures and sells home furnishings (example taken from James Creelman's Building and Communicated Shareholder Value, London: Business Intelligence, 2000). All figures are in thousands of US dollars.

EVA is used as a way to evaluate an organization's investment. Let's take the example of a packaging line that is no longer meeting customer requirements. The new line will help the organization generate additional income as well as reduce packaging costs. The total effect is estimated to be an increase in profit after tax (net income) of £2 million. However, additional operating capital of £7.5m is required. Assuming a cost of capital of 11%, we obtain the following results:

• Increase in net income (NOPAT) - £2 million.
• The cost of additional operating capital (11% of 7.5 million) is £0.8 million.
• Economic value added = 2 - 0.8 = £1.2 million.

Notes

The introduction of EVA is more a change in corporate culture than a financial one. Organizations must ensure that they have created a culture in which economic performance is much more important than just profit and loss.

Opponents of EVA argue that changing "accounting distortions" makes the method too complex. For this reason, some companies do not correct the "misstatements" but simply subtract the cost of capital from after-tax net operating income.

Moreover, making decisions based on estimated EVA values ​​may deter managers from making risky investments. Organizations need to determine their risk appetite along with their preferred EVA values.

Economic value added (EVA) is the real economic profit that accrues to shareholders after deducting all operating expenses (including taxes) and financing costs. Since EVA is the official trademark of Stern Stewart Management Services of New York City, another term, Economic Profit (EP), is often used.

EVA = (return on capital - cost of capital) x (investment capital).

For example, a firm's return is 10% on $1 million and its cost of capital is 11%, then:

EVA = (10%-11%) * 1,000,000 = - $10,000

This example shows the importance of EVA. A 10% return may sound "optimistic", but it is less than the company's cost of capital, and EVA objectively shows that the value added in this example is negative.

EVA vs other economic indicators.

In fact, EVA is not a new idea, the concept is very closely related to the concept of “residual value”, first introduced by Alfred Marshall in 1980. It is also close to the concepts of discounted cash flow (DCF) and net present value (NPV).

As follows from the above example, this indicator (EVA) is better than “income” or return on assets (ROA), because these two measures do not take into account the cost of capital.

Difficulties and disadvantages.

The definition of EVA is based on the cost of capital, its return and investability, and assumes that you can measure them. In practice, there are certain difficulties. For example, if you measure investment capital based on book value, you will underestimate the true value of assets.

Almost all accounting indicators have certain shortcomings, often to a greater extent than is acceptable for an objective assessment, and the use of EVA leads to the same difficulties. The reliability of this metric deteriorates if you try to use it for each business unit, because you will face the inevitable problem of overhead allocation. Calculating EVA will require significant effort on the part of your accounting department.

In addition, EVA is an indicator that refers to the past. If you make an investment that won't pay off for a number of years, the EVA will be negative until the investment starts making a profit. Like profit, EVA is a short-term indicator not focused on a long-term strategy.

EVA ignores the value of real options (or, more often, incorrectly values ​​them at 0).

EVA and personnel management.

Very often, EVA is positioned as the best indicator for calculating bonuses. It has a number of advantages for use over such an indicator as “income”, because includes the cost of capital.

Additionally, traditionally, managers want to maximize investment in their divisions, and if their compensation is dependent on EVA, they will only want additional investment if EVA is positive.

Is EVA really that good?

It's hard to understand the hype that has existed around EVA over the last decade. EVA was positioned as the best way to bring together the interests of workers and business owners. This is actually not that true. We prefer the more robust approach developed by Kaplan and Norton. In any case, any social scientist knows that “bonuses” are just one small part of an effective behavioral management system.

As noted earlier, EVA, like all other indicators, has a certain set of limitations and shortcomings that make it far from perfect.

EVA is the same tool as FIFO or LIFO - however, there is no excessive hype around these methods. However, no one denies its usefulness in business and personnel management, but it is important to understand all its limitations and not idealize it.

Translation: Eputaev Ian