Economic Value Added (EVA)

What is Economic Value Added (EVA)?

Economic Value Added (EVA) is a financial metric that helps measure the value a company generates for its shareholders. It provides a way to assess the profitability of a company by considering both its operating profits and the capital employed to generate those profits.

To understand EVA, let's break down the description provided. Operating profits refer to the earnings a company generates from its core business activities, such as selling products or providing services. These profits are calculated after deducting various expenses, including taxes.

However, simply looking at operating profits alone does not give a complete picture of a company's performance. This is where EVA comes in. EVA takes into account the capital used by the company to generate those profits. Capital refers to the money invested in the company's assets, such as buildings, equipment, and inventory.

By subtracting an appropriate charge for the capital employed from the operating profits, EVA provides a more accurate measure of the value created by the company. This charge for capital is often referred to as the cost of capital or the opportunity cost of using that capital in the business.

The concept behind EVA is that a company should not only generate profits but also earn a return on the capital invested. If the company's operating profits exceed the cost of capital, it means the company is creating value for its shareholders. On the other hand, if the operating profits are lower than the cost of capital, it indicates that the company is not generating enough value.

EVA is a useful tool for evaluating the financial performance of a company over time. By tracking changes in EVA, investors and managers can assess whether the company is becoming more or less profitable and whether it is effectively utilizing its capital.

Furthermore, EVA can also be used to compare the performance of different companies within the same industry. By calculating and comparing their respective EVAs, investors can identify which companies are creating more value for their shareholders.

In summary, Economic Value Added (EVA) is a financial metric that measures the value a company generates for its shareholders by considering both its operating profits and the capital employed. It provides a more comprehensive assessment of a company's profitability and helps evaluate its performance over time. EVA is a valuable tool for investors and managers to make informed decisions and compare the performance of different companies.