Economic value added (EVA)

Economic Value Added, or EVA, estimates economic profit by subtracting the full cost of financing operating capital from after-tax operating profit. Stern Stewart developed the branded methodology to make the opportunity cost of debt and equity visible in internal decisions.

When to use it

• Answer the key performance question: “How well are we delivering value to our shareholders?”
• Assess this KPI within the Financial perspective.
• Plan data collection, formula use, reporting frequency, and data-source requirements for this KPI.
• Compare results against the targets, benchmarks, examples, or trend guidance available for this KPI.

Origins

Economic profit descends from classical economics and the accounting idea of residual income. Joel Stern and G. Bennett Stewart adapted that lineage through Stern Stewart & Co., founded in nineteen eighty-two, defining accounting adjustments and trademarking Economic Value Added. The method asks whether NOPAT exceeds a charge for every dollar of operating capital.

What it is

Perspective: Financial perspective.

Key performance question: How well are we delivering value to our shareholders?

EVA can operate as a governance and investment measure: managers are expected to improve operating returns while recognising that capital is scarce and carries an opportunity cost.

The method often adjusts conventional accounting where treatment obscures economic investment. Research, development or training may be capitalised and amortised when they create multi-period benefits. The objective is not to manufacture a better result, but to improve the match between measured profit and the capital that produced it.

Debt and equity both belong in the capital base. Investors could place funds in bonds, deposits or other equities, so a company creates economic profit only after compensating them for the return available elsewhere at comparable risk.

Some organisations connect incentives to improvement in EVA through a bonus bank. A declared award is deposited, part is paid and the balance remains at risk against later performance. This design can reward a business unit for improving a negative EVA while withholding reward when a positive result deteriorates. It aims to align managers with investors across more than one reporting period.

How to use it

Measurement

Data collection method

Start with the income statement and operating balance sheet, calculate the capital charge and apply only documented adjustments that improve economic comparability.