Performance Measurement: A Comparative Study of EVA and Traditional Performance Measurement Techniques

A Case Study of Steel and Petrochemicals Industry in India


Textbook, 2011
186 Pages

Excerpt

Contents

1 Introduction

2 Literature Review

3 The Analysis

4 Conclusion& Suggestions

Bibliography

Reference Tables

Chapter-1: Introduction

Introduction

Meaning of Performance Measurement

Moullin defined performance measurement as, “Performance measurement is evaluating how well organizations are managed and the value they deliver for customers and other stakeholders”. Performance measurement is the ongoing monitoring and reporting of program accomplishments, particularly progress towards pre established goals. Performance measurement is the process whereby an organization establishes the parameters within which programs, investments, and acquisitions are reaching the desired results.

Objectives of Performance Measurement

Organizations measure their performance for numerous reasons. The main objectives of performance measurement in the organizations’ are as follows:

1. Improvement in the processes by continuous monitoring of the operations.
2. Planning and forecasting by serving as a progress check.
3. Meeting competition by identifying weak areas and addressing them to sharpen their competitive edge at the earliest.
4. Rewarding and motivating the employees who have excelled in achieving goals.

5. To help the organizations in complying with government regulations and standards such as anti pollution laws or international standards like ISO 9000.

Exhibit 1.1

Performance Measurement Process Model

Abbildung in dieser Leseprobe nicht enthalten

Significance of Performance Measurement

According to Kelvin, ‘When you can measure what you are speaking about and express it in numbers, you know something about it’. According to Anon, ‘You cannot manage what you cannot measure’. Performance Measures are objective, quantitative indicators of various aspects of performance of different organizations.

Performance Measurement is an effective tool to improve service delivery and cost effectiveness in both public and private sectors. Successful performance measurement requires self-directed and cross-functional work teams and the supporting infrastructure to make it work. The scope of performance measurement in the public sector is particularly difficult in some instances, largely because it is difficult to define the bottom line in public service. The concept of performance measurement is to include or cross over on important topics such as accountability and empowerment.

Performance Measurement can be used in each type of organization whether it is private, public, profit, non-profit, manufacturing, service or technology oriented organization. The main idea is to measure the performance so that corrective action can be taken at the earliest to improve or maintain the performance. Performance Measurement has been successful in health care and information technology Industries. In government sector too, it can be used as to tool to measure the performance of the respective departments and further improve the operations.

Techniques of Performance Measurement

There are several performance measurement tools and techniques and each has its own group of supporters. The techniques have been divided into two categories:

a. Traditional Methods

b. Modern Techniques

A. Traditional Methods: The traditional methods are based on earnings. For years, managers have been using these traditional methods to measure the financial performance. Some of the main traditional measures used in performance measurement are:

1. Ratio Analysis
a. Return on Assets
b. Return on Equity
c. Earnings per share

2. Net Income

3. Market Value Added

4. Cash Flow Statement

5. Funds Flow Statement

6. Financial Statement Analysis
a. Comparative Statements
b. Common Size Statements

7. Marginal Costing

8. Differential Cost Analysis

9. Break Even Analysis

10. Standard Costing

11. Variance Costing

12. Budgetary Control

B. Modern Techniques or Approaches: In a successful total quality organization, performance will be measured by the improvements seen by the customer as well as by the results delivered to other stakeholders, such as the shareholders. Viewing the performance of an organization is also an important step when formulating the direction of the strategic activities. Modern Approaches take into consideration the wealth maximization concept and other non financial aspects like innovation, customer satisfaction, employees’ motivation etc. Some of the modern techniques are as follows:

1. The Balanced Scorecard (Kaplan and Norton, 1993, 1996, 2001)
2. Performance Prism (Neely, 2002),
3. The Cambridge Performance Measurement Process (Neely, 1996)
4. TPM Process (Jones and Schilling, 2000)
5. 7-Step TPM Process (Zigon, 1999)
6. Total Measurement Development Method (TMDM) (Tarkenton Productivity Group, 2000)
7. Activity-based Costing and Management
8. Economic Value Added (EVA)
9. Quality Management
10. Customer Value Analysis

Performance measurement systems should align with the organization’s strategy and senior managers should convey the organization’s mission, vision, values and strategic direction to employees and external stakeholders. The performance measures give life to the mission, vision, and strategy by providing a focus that lets each employee know how they contribute to the success of the company and its stakeholders’ measurable expectations. Performance measurement is essential for the effective working of an organization as it monitors the weaknesses at the earliest and warns the managers to take the corrective action as soon as possible.

Stock price maximization is the most widely accepted objective of listed firms worldwide. The entire corporate decision-making framework revolves around this comprehensive framework. The metrics of financial performance are important in the corporate and investors' decision-making to the extent they influence the stock prices. Traditionally accounting based measures of financial performance like EPS, ROI, ROE etc. have been found to influence the stock prices but of late due to vulnerability of these measures to accounting distortions these measures are finding fewer acceptances among the investors. The Economic Value Added (EVA) framework developed by the Stern Stewart & Company is gradually replacing the traditional measures of financial performance due to its robustness and its immunity from "creative accounting".

Fortune magazine has called it "today's hottest financial idea and getting hotter" and management guru Peter Drucker referred to it as a measure of total factor productivity. Companies across a broad spectrum of industries and a wide range of countries have joined the EVA bandwagon and have started reporting their EVA numbers.

Meaning of EVA

EVA is a registered trademark by its developer, Stern Stewart & Co . Economic Value Added or EVA is an estimate of true economic profit after making corrective adjustments to GAAP accounting, including deducting the opportunity cost of equity capital. By taking all capital costs into account, including the cost of equity, EVA shows the financial amount of wealth a business has created or destroyed in a reporting period.

The EVA Theory

EVA can be calculated as follows:

EVA = NOPAT- WACC × CAPITAL EMPLOYED

Where

NOPAT refers to net operating profits after taxes. NOPAT is equal to earnings before interest and tax (EBIT) minus adjusted taxes (AT).

EBIT refers to the earnings before interest and tax. Following accounting items are not to be considered:

A. Income

1. Interest income on loans given by the company
2. Dividend income on financial investments made by the company
3. Profit on sale of assets
4. Profit on sale of investments

B. Expenses

1. Loss on sale of fixed assets
2. Loss on sale of investments
3. Expenses by subsidiaries

Others Issues

1. Brand expenses: The expenses incurred in brand development should be amortized over a period of years in case the brand is launched and the same survives over the period. The expenses incurred on a brand not subsequently launched should be written off in the same year rather than amortizing the same over a period of years.

2. Capitalization of R&D expenses: Similarly, only those R&D expenses which contribute to the revenue in future periods should be deferred. Else, they be written off in these years when they are incurred.

3. Currency translation: The reversible currency translation effects should be ignored. The irreversible, periodic and gradual translation effects should be considered to the extent they result in losses. Gains should be ignored to be on conservative side.

4. Sinking fund depreciation: The depreciation should be charged in line with the utilized life of assets. However, cases with steady capital investment policy would not require this adjustment.

The objective behind all these adjustments is to reflect the operational efficiency of the company under purview.

AT refers to the adjusted taxes. It is calculated as:

AT = Cash Taxes Paid + Tax Advantage on Interest

WACC refers to weighted average cost of capital. It comprises of following two components:

1. Cost of debt: Company's post tax marginal rate of borrowing.

Cost of Debt = Borrowing rate × (1-marginal tax rate)

2. Cost of equity: Required rate of return on company's share.

Cost of Equity = Risk free rate + Risk premium × Beta (Capital Asset Pricing Model)

We have used another method of calculating Cost of Equity i.e

Earnings Per Share/Market Price Per Share

WACC = D/V × Cost of Debt + E/V × Cost of Equity

Where,

a. D = Average debt

b. E = Average equity (market capitalization)

c. V = D + E (Total value of firm)

d. The risk free rate is equivalent to government's long-term bond yield

e. Beta measures the volatility of share price relative to the market

f. Market risk premium is the extra return investors expect from equity market over and above risk free rate

Capital Employed: Capital employed is taken to be total assets subtracted with non-interest bearing liability in the beginning of the period. This definition does not consider the capital infused into the business at different times during the year and hence has a favorable impact on the resulting values. However, use of average capital employed shall correct this bias. Following points should be remembered:

a. Exclude the profits from the ending balance sheet.

b. Exclude capital work-in-progress since it does not give any returns till commissioned.

c. Funds locked in investments should be excluded.

d. Add customer advance where it is considerable.

e. Average assets can be calculated on average of individual months.

Principles of EVA

EVA was developed to help managers to incorporate two basic principles of finance into their decision making:

1. The primary financial objective of any company should be to maximize the wealth of its shareholders.

2. The value of a company depends on the extent to which investors expect that future profits will differ from the cost of capital. By definition, a sustained increase in EVA will result in an increase in the market value of a company. This approach has proved valid and effective for many types of organizations. This is because the level of EVA isn't what really matters. Current performance already is reflected in share prices. It is the continuous improvement in EVA that brings continuous increases in shareholder wealth.

Objectives of EVA

Economic Value Added is one among various frameworks within value based management framework. EVA is based on the common accounting based items like interest bearing debt, equity capital, net operating profit etc. The idea behind EVA is that shareholder must earn a return that compensates the risks taken by him. The main objectives of EVA are given below:

1. The foremost objective of the EVA is the true performance measurement of an organization after taking into consideration the stakeholders’ perspective.

2. The main objective of EVA is to determine which business units’ best utilize their assets to generate returns and maximize shareholder value; it can be used to assess a company, a business unit, a single plant, office, or even an assembly line.

3. Economic value added EVA aims at determining a company's true profit, once taxes and the cost of supporting capital have been taken into account. It helps to identify whether a business or project is earning more or less than the capital originally invested in it.

4. Economic Value Added EVA aims to ascertain the financial health of the organization and its capacity to generate shareholder ‘value' respectively.

5. EVA aims at the financial assessment of an organization which is important for the company’s long range success and planning.

6. Economic Value Added EVA is a financial tool, which signifies the gain, or loss that remains after assessing a charge for the cost for all types of capital employed in an organization. EVA helps in ascertaining the ‘value' of the organization in a given time period.

7. The other objective of EVA is to help the managers in setting organizational goals on the basis of financial assessment and keeping into consideration the main motive of shareholders wealth maximization.

8. EVA gives the true economic profit and helps the managers in determining the bonuses, corporation valuation and analyzing equities. It aims at acting as a motivator of the managers and presenter of the true and fair picture of the organization to the investors and the shareholders.

For many years, managers and shareholders have believed that growth in annual earnings per share and increases in return on equity were the best measures for maximizing shareholder wealth. However, more recently there has been a growing awareness that these conventional accounting measures are not reliably linked to increasing the value of the company’s shares. This occurs because earnings do not reflect changes in risk and inflation, nor do they take account of the cost of additional capital invested to finance growth. There are a number of other reasons why earnings fail to measure changes in the economic value of the business. These are:

1. Alternative accounting methods may be employed.
2. Dividend policy is not considered.
3. The time value of money is ignored.

The traditional performance measures, based on cost accounting information, provide little to support organizations on their quality journey, because they do not map process performance and improvements seen by the customer. In a successful total quality organization, performance will be measured by the improvements seen by the customer as well as by the results delivered to other stakeholders, such as the shareholders.

Ratio Analysis

Financial ratio analysis is the calculation and comparison of ratios which are derived from the information in a company's financial statements. The level and historical trends of these ratios can be used to make inferences about a company's financial condition, its operations and attractiveness as an investment.

Financial ratios are calculated from one or more pieces of information from a company's financial statements. A ratio gains utility by comparison to other data and standards. Financial ratio analysis groups the ratios into categories which tell us about different facets of a company's finances and operations. An overview of some of the categories of ratios is given below:

- Leverage Ratios which show the extent that debt is used in a company's capital structure.
- Liquidity Ratio s which give a picture of a company's short term financial situation or solvency.
- Operational Ratios which use turnover measures to show how efficient a company is in its operations and use of assets.
- Profitability Ratios which use margin analysis and show the return on sales and capital employed.
- Solvency Ratios which give a picture of a company's ability to generate cashflow and pay it financial obligations.

Although financial ratio analysis is well-developed and the actual ratios are well-known, practicing financial analysts often develop their own measures for particular industries and even individual companies. Analysts will often differ drastically in their conclusions from the same ratio analysis. The following ratios are discussed under ratio analysis:

Return on Assets

The return on assets (ROA) percentage shows how profitable a company's assets are in generating revenue.

ROA can be computed as:

ROA= Net income + Interest Expense – Interest Tax Savings

Average total assets

This ratio tells what the company can do with what it has, i.e. how many Rupees of earnings they derive from each Rupee of assets they control. It is a useful number for comparing competing companies in the same industry. The number will vary widely across different industries. Return on assets gives an indication of the capital intensity of the company, which will depend on the industry; companies that require large initial investments will generally have lower return on assets.

Return on assets is an indicator of how profitable a company is before leverage, and is compared with companies in the same industry. Since the figure for total assets of the company depends on the carrying value of the assets, some caution is required for companies whose carrying value may not correspond to the actual market value. Return on assets is a common figure used for comparing performance of financial institutions (such as banks), because the majority of their assets will have a carrying value that is close to their actual market value.

Return on Equity

Return on Equity (ROE), Return on average common equity, return on net worth measures the rate of return on the ownership interest (shareholders' equity) of the common stock owners. It measures a firm's efficiency at generating profits from every dollar of shareholders' equity (also known as net assets or assets minus liabilities). It shows how well a company uses investment dollars to generate earnings growth. ROE is equal to a fiscal year's net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage.

ROE= Net income

Shareholder equity

Earnings per Share

Earnings per share (EPS) are the earnings returned on the initial investment amount. The EPS formula does not include preferred dividends for categories outside of continued operations and net income. Earnings per share for continuing operations and net income are more complicated in that any preferred dividends are removed from net income before calculating EPS.

Earnings Per Share (Basic Formula) = Profit

Weighted average common shares

Earnings Per Share (Net Income Formula) = Net Income

Weighted average common shares

Earnings Per Share (Continuing Operations Formula) = Income from Operations

Weighted average common shares

Here, operations are continuing.

Net Income

Net income is equal to the income that a firm has after subtracting costs and expenses from the total revenue. Net income can be distributed among holders of common stock as a dividend or held by the firm as retained earnings. Net income is an accounting term. In some countries (such as the UK) profit is the usual term. Often, the term income is substituted for net income, yet this is not preferred due to the possible ambiguity.

The items deducted will typically include tax expense, financing expense (interest expense), and minority interest. Likewise, preferred stock dividends will be subtracted too, though they are not an expense. For a merchandising company, subtracted costs may be the cost of goods sold, sales discounts, and sales returns and allowances. For a product company advertising, manufacturing, and design and development costs are included. Net income is informally called the bottom line because it is typically found on the last line of a company's income statement. A related term is top line, meaning revenue, which forms the first line of the account statement.

Net income or net loss = Revenue – Cost of goods sold – Sales discounts – Sales returns and allowances – Expenses – Minority interest – Preferred stock dividends

Market Value Added

Market Value Added (MVA) is the difference between the current market value of a firm and the capital contributed by investors. If MVA is positive, the firm has added value. If it is negative, the firm has destroyed value. The amount of value added needs to be greater than the firm's investors could have achieved investing in the market portfolio, adjusted for the leverage (beta coefficient) of the firm relative to the market.

Calculation of Market Value Added.

Market Value Added (MVA) = Market Value - Invested Capital.

The higher the Market Value Added (MVA) is, the better it is. A high MVA indicates the company has created substantial wealth for the shareholders. MVA is equivalent to the present value of all future expected EVAs. Negative MVA means that the value of the actions and investments of management is less than the value of the capital contributed to the company by the capital markets. This means that wealth or value has been destroyed. The aim of a firm should be to maximize MVA. The aim should not be to maximize the value of the firm, since this can be easily accomplished by investing ever-increasing amounts of capital.

Cash Flow Statements

The cash flow statement shows how much cash comes in and goes out of the company over the quarter or the year. Cash flow statement shows how much actual cash a company has generated, the statement of cash flows is critical to understanding a company's fundamentals. It shows how the company is able to pay for its operations and future growth.

Companies produce and consume cash in different ways, so the cash flow statement is divided into three sections: cash flows from operations, financing and investing. Iinvestors are attracted to companies that produce plenty of free cash flow (FCF).

Free Cash Flow = Net Income + Amortization/depreciation – Changes in Working Capital – Capital Expenditures

Funds Flow Statement

Fund flow statement also referred to as statement of “source and application of funds” provides insight into the movement of funds and helps to understand the changes in the structure of assets, liabilities and equity capital. The information required for the preparation of funds flow statement is drawn from the basic financial statements such as the Balance Sheet and Profit and loss account. “Funds Flow Statement” can be prepared on total resource basis, working capital basis and cash basis. The most commonly accepted form of fund flow is the one prepared on working capital basis.

Financial Statements Analysis

Financial Statement Analysis will help business owners and other interested people to analyse the data in financial statements to provide them with better information about such key factors for decision making and ultimate business survival. It is done to evaluate an organisation’s financial performance and financial position. It is done to have a means of comparative analysis across time in terms of intra company basis (within the company itself), intercompany basis (between companies) and industry averages (against that particular industry’s averages). It is done to apply analytical tools and techniques to financial statements to obtain useful information to aid decision making. It includes the following:

A. Comparative statements: Comparative statements are financial statements that cover a different time frame, but are formatted in a manner that makes comparing line items from one period to those of a different period an easy process. This quality means that the comparative statement is a financial statement that lends itself well to the process of comparative analysis. Many companies make use of standardized formats in accounting functions that make the generation of a comparative statement quick and easy.

B. Common-size Statement: The common-size statement is a financial document that is often utilized as a quick and easy reference for the finances of a corporation or business. Unlike balance sheets and other financial statements, the common-size statement does not reflect exact figures for each line item. Instead, the structure of the common sizes statement uses a common base figure, and assigns a percentage of that figure to each line item or category reflected on the document.

Marginal Costing

It is a costing technique where only variable cost or direct cost will be charged to the cost unit produced. Marginal costing also shows the effect on profit of changes in volume/type of output by differentiating between fixed and variable costs. It is a costing technique where only variable cost or direct cost will be charged to the cost unit produced. Marginal costing also shows the effect on profit of changes in volume/type of output by differentiating between fixed and variable costs. Marginal costing involves ascertaining marginal costs. Since marginal costs are direct cost, this costing technique is also known as direct costing. In marginal costing, fixed costs are never charged to production. They are treated as period charge and is written off to the profit and loss account in the period incurred. Once marginal cost is ascertained contribution can be computed. Contribution is the excess of revenue over marginal costs. The marginal cost statement is the basic document/format to capture the marginal costs.

Differential Cost Analysis

Differential Cost Analysis is a decision making technique in which evaluation is confined to only those factors which are different or unique among possible alternatives. It is also called incremental analysis or relevant cost analysis. It usually involves four steps:

1. Compute all costs associated with each alternative.
2. Ignore the sunk costs.
3. Ignore costs that remain largely constant among the alternatives.
4. Select the alternative offering the best cost-to-benefit ratio.

Differential Cost Analysis focus on only those items that differ provides a clearer picture of the impact of the decision at hand. It is easier and quicker to prepare.

Break Even Analysis

A breakeven analysis is used to determine how much sales volume your business needs to start making a profit. The breakeven analysis is especially useful when you're developing a pricing strategy, either as part of a marketing plan or a business plan.

The break-even point for a product is the point where total revenue received equals the total costs associated with the sale of the product (TR=TC). A break-even point is typically calculated in order for businesses to determine if it would be profitable to sell a proposed product, as opposed to attempting to modify an existing product instead so it can be made lucrative. Break even analysis can also be used to analyse the potential profitability of an expenditure in a sales-based business.

Break even point (for output) = Fixed Cost

Contribution per unit

Contribution (per unit) = Selling Price (per unit) - Variable Cost (per unit)

Break even point (for sales) = Fixed cost

Contribution (per unit) x Selling Price (per unit)

Standard Costing

Standard costing is a technique which helps to control costs and business operations. It aims at eliminating wastes and increasing efficiency in performance through setting up standards or formulating cost plans. The word standard means a benchmark or yardstick. The standard cost is a predetermined cost which determines in advance what each product or service should cost under given circumstances. It is a system of cost accounting which is designed to find out how much should be the cost of a product under the existing conditions. The actual cost can be ascertained only when production is undertaken. The predetermined cost is compared to the actual cost and a variance between the two enables the management to take necessary corrective measures.

Variance Analysis

Variance analysis is usually associated with explaining the difference (or variance) between actual costs and the standard costs allowed for the good output. Variance analysis helps management to understand the present costs and then to control future costs.

Variance analysis is also used to explain the difference between the actual sales and the budgeted sales.

Budgetary Control

Budgetary control can be defined as, “A means of achieving the financial control of an entity whereby the actual results for a defined period of time are compared with the budgeted results, any differences (or variances) being noted, and some corrective action taken to bring the actual activities back into line with the budgeted ones if such variances need to be dealt with.” The budgetary control is a continuous process that helps in planning, coordination and controlling of business decisions. A budget is a means and budgetary control is the end-result. The budgetary control system assists an organization in setting up the goals and efforts are made for its achievements. It enables economies in the enterprise.

The traditional measures for performance measurement, suffer from some serious limitations which are the main reason that these traditional methods based on earnings can’t be used as a reliable measure of performance measurement. Hence, there is the need of new approaches for the performance measurement which takes stakeholder’s perspective into consideration and shareholders wealth into consideration.

Chapter-2: Literature Review

A. Past Scenario

The concept of value addition has been evolved for the measurement of wealth created by an organization and it is considered as an approach for the measurement of performance in terms of operational efficiency and profitability of a business. The concept of value addition may be viewed from two different angles: (I) value addition for the stakeholders, customers and for the community at large which can be measured in terms of Gross Value Added (GVA) and Net Value added (NVA). It can be used to indicate the overall performance of an enterprise instead of profit only; and, (ii) value addition for the shareholders (i.e. owners) which can be measured in terms of Cash Value Added (CVA) as suggested by Holt Value Associates, shareholders Value Added (SVA) as developed by Rapport and Lek / Alcar Consulting Group and Economic Value Added as postulated by Stern and Stewart Consulting Co. etc. Stewart (1991) coined the term Market Value Added (MVA) to measure shareholders wealth. MVA is defined as the absolute rupee spread between a company’s market value and its invested capital.

It has been argued by many experts that EVA is not the ultimate measure of corporate performance. The long-term success of management of a firm can best be measured by MVA. However, MVA cannot be computed for private owned firms and non – profit companies because share of those companies cannot be traded. Moreover, MVA can be viewed as a useful performance measure only at the top-level organization but, not at the subsidiary level.

B. The Individual Assessment of EVA

Stern, J. (1990): ‘As a performance measure EVA comes too closer than any other tool to capture the true economic profit of an enterprise. It is directly linked to the creation of the shareholders wealth over time. EVA based financial management and incentive system gives manager superior information and motivation to make decisions that will create the greatest shareholder private enterpriser’.

Easton, P., Harris, T. and Ohlson, J. (1992) : ‘Economic Value Added (EVA) Is an increasingly popular corporate performance measure one that is often used by Companies not only for evaluating performance, but also as a basis for determining incentive pay. Like other performance measures, EVA attempts to cope with the basic Tension that exists between the need to come up with a performance measure that is highly correlated with shareholders wealth, but at the same time somewhat less subject to the random fluctuations in stock prices. This is a difficult tension to resolve, and it explains the relatively low correlations of all accounting based performance measures with stock returns, at least on a year-to-year basis’.

Vessel, E. (1993): ‘We like to invest in companies that use EVA and similar measures. Making higher return than the cost of capital is how we look at the world’.

Stewart, III. And Benett, G. (1994): ‘EVA is a powerful new management tool that has gained growing international acceptance as the standard of corporate governance. It serves as the centerpiece of a completely integrated framework of financial management and incentive compensation’.

Riley, M.J. (1995): ‘EVA brings together all aspects of the business into one measure. It changes the focus from the traditional government culture. We will learn to grow revenue only when it is profitable, to invest more only when it produces a good return, and reduce expenses only when it does not hurt serve’.

Rice, V, A. (1996): ‘Previously we used several measurements to gauge our financial outflow from earnings per share to discounted cash flow return on Average assets. With EVA, I saw a way to meet our business objectives and create a new corporate culture. It parameters every level at verity from Board room to Shop floor. Bonuses of all managers are determined solely by whether verity achieves its EVA targets. At our company every decisions and every action result from analysis that uses EVA principles; we focus on ensuring that every investment produces a return that exceeds our cost of capital. We believe this approach enables us to directly align management and shareholders inters’.

Milunovich, S. and Tsuci, A. (1996): Although Eva is not a panacea; the Measure can become an essential management tool. When properly implemented, EVA forms the backbone of a powerful management approach. EVA instills capital discipline by forcing managers to consider the actual cost of the capital they employ. Thus, EVA encourages managers to act as owners. Linking management compensation to Eva generation reinforces this relationship’.

Ruggiero, A.W. (1996) : ‘The EVA approach revealed many insights about the performance of business units which had been unnoticed or obscured by the more traditional measures of profit growth, profit margin, revenue growth and EPS growth’.

Morgan, C.D. (1996): ‘In 1993 and 1994, we attended several Stern and Stewart conferences and in December 1994 we committed to EVA training of our executives. We feel offered an opportunity to fill in the missing gaps that we has in our official. I allowed us to take a long, hard look at operating costs, which are now fully understood, and capital charges. We had every difficult time trying to figure out how to actively compare and measure results across the disparity of our different business units. Linking EVA to ABM allowed us to do that’.

Jackson, A. (1996): ‘What do I see as advantages of using EVA? I Measures the required economic return on all invested capital. It makes you to invest in positive spread projects, and it gets you to eliminate operations where returns are negative. It gets management to think about how you manage the capital in the businesses.

Tobias, R. (1996): ‘As we are making decisions we have got to think about aligning them with, EVA. It’s very easy to see EVA as a very sophisticated financial tool, and indeed it is, but I think it is important to understand that is really a tool to change behavior too. Linking bonuses to EVA is meant to change the whole culture’.

Stern, J. (1997): ‘EVA as a tool of financial management was neither just a US phenomenon nor it is limited to for profits organizations. It had been put to use for management performance evaluation for imposing scarce capital allocation and for valuation of Target Company at the time of acquisition. It strengthens management incentives in a way that does not dilute shareholder interest’.

Bacidore, J.M., Boquist, J.A., Milbourn, T.T. and Thakor, A.V. (1997) :‘By subjecting Total Quality Management (TQM) to the discipline of EVA, management is in a better position to ensure that its investment in TQM is translating into increased shareholder value. At the same time a TQM Programme tempered by EVA can help managers to ensure that they are not under investing in their non – shareholder stakeholders’.

Bacidore, J.M., Boquist, J.A., Milbourn, T.T. and Thakor, A.V. (1997) : ‘If EVA based NPV (Net Present Value) and cash flow based NPV are identical, why is it that EVA is useful for compensation and NPV is not? The reason is that one needs flow measures of performance for periodic compensation since compensation is designed to provide a flow of rewards. EVA is a flow measure, whereas NPV is a stock measure. Moreover, of the available flow measure, EVA is the only one that explicitly takes into account the cost of capital provided by shareholders. In this respect it is superior to another flow measures, cash flow’.

C. Findings of Research Studies:

Banerjee, A. (1997): The study selected 10 industries in India taking 4/5 Companies from each industry to examine whether EVA is equally available in Indian condition. The study has been mainly undertaken to find the superiority of EVA over ROI. The study shows that companies having identical ROI report significantly different EVAs. EVA has been viewed as the centerpiece of a comprehensive financial measurement system. The study has also found the Indian companies slowly recognizing the importance of EVA arid attempting to use it as a better discloser practice.

KPMG-BS Study (1998): The study assessed top 100 companies on EVA, Sales, and PAT and MVA criteria. The survey has used the BS-1000 list of companies using a composite index comprising sales, profitability and compounded annual growth rate of those companies covering the period 1996-97. Sixty companies have been found able to create positive shareholder value whereas 38 companies have been found to destroy it. Accounting numbers have failed to capture shareholder value creation or destruction as per the findings of the study. 24 companies have destroyed shareholder value by reporting negative MVA.

Banerjee, A. and Jain, S.C. (1999): ‘The researches conducted a study to find the relationship between shareholder wealth and certain financial variables. Five independent variables, viz. Earnings Per Shares (EPS), Average Return On Net Worth (ARONW), Capital Productivity (KP), Labour Productivity (LP) and Economic Value Added (EVA) have been chosen to establish the relationship with Market Value Added (MVA), the shareholder wealth surrogate. Top 50 companies from the Drugs and Pharmaceuticals Industry on India were chosen as sample companies and data were colleted for a period of 8 years from 1990-91 to 1997-98.

In five years of the study period EVA turned out to be significant, predictor of MVA. Traditional accounting measures like EPS and ARONW have insignificant relationship with shareholder wealth. In the said study EVA figures were computed by the researchers whereas EPS, ARONW were disclosed information’.

Banerjee, A. (1999): ‘In line of previous work conducted by the same Researchers, the present study attempts to explore the supremacy of EVA over other variable in the stock price performance. Five independent variables viz. EPS, ARONW, Kp, Lp and EVA are chosen to establish relationship with MVA. Nine industries have chosen for the study with varied number of companies from year to year. Necessary data to compute the above variables are collected for a period of 8 years from 19990-91 to 1997-98. The study concludes that EVA is an important explanatory variable of the shareholder wealth. The study has also found the companies, which have started disclosing EVA results in their Annual Reports to face a direct impact on stock prices. The two variables relating to productivity capital and labour have been found as better predictors than the traditional measures like EPS and ARONW. The correlation coefficient results were found to be the highest between EVA and MVA in five years of the study’.

Bao, B.H. and Bao, D.H. (1999): ‘The study reveals the association between EVA and the value of the Indian firms which are included in the COMPUSTAT – Global Vantage database. The results of the study show that the EVA is positively and significantly correlated with the firm value. They are consistent with the theory in that firms with EVA created value and firms with higher created value higher stock prices. The study also reveals that explanatory power of EVA is lower than that of earnings and book value of firms under consideration’.

Parasuram, N.R. (2000): ‘The study covers the position of 14 major public Sector banks, 7 new private sector banks, 5 old private sector banks and 2 foreign banks. Among the strength indicators, deposit, return on assets, interest income as a percentage of total assets, interest yield spread as a percentage of total assets and EVA were considered. The study concludes that EVA is an important measure to judge a bank performance in view of the current scenario of banks. EVA has been found to have a high degree of correlation with ROI but not with any of the other measures. It signifies a fact that banks realize the importance of measuring EVA separately even if they do well on other fields. Some of the banks have high net profit and otherwise ranked high have been found to have a negative EVA. The study expects that EVA will soon displace other measures of bank performance’.

Banerjee, A. (2000): ‘The study selected 200 companies across industries in India spanning over a period from 1993-94 to 1997-98. The study observed a huge gap in many cases between actual market value and the sum total of Current Operational Value (COV) and future Growth Value (FGV). The results also show that independent variables (COV and FGV) significantly explain the variation in market value. The study observed that the market value of a firm could be well predicted by future EVA streams’.

Thenmozhi, M. (2000): In order to have an understanding of how the Traditional performance measures are comparable to EVA, data of three financial years between 1996 and 1999 were chosen from 28 companies. Only 6 out to the 28 companies have positive EVA while the others have negative. The EVA as a percentage of capital employed (EVA/CE) has been found to indicate the true return on capital employed. Comparing EVA with other traditional performance measures the study indicates that all the companies’ depict a rosy picture in terms of EPS, RONW and ROCE for all the three years. The study shows that the traditional measures do not reflect the real value of shareholders and EVA has to be measure to have an idea about the shareholders value’.

Thampy, A. and Beheli, R. (2001): ‘The study measures the economic value Addition (EVA) by Indian commercial banks in the public and private sectors during 1990s. It also moves the benchmark of performance of banks from accounting, profits to economic profits and shareholder wealth creation. The study has been restricted to 12 commercial banks consisting of 4 public and 8 private sector banks. The period covered under the study is three years starting from 1995-96 to 1997-98. Beta has been calculated on the basis of daily stock price data with Bombay Stock Exchange’s BSE 200 index returns during January 1, 1997 to March 31, 1998 as the proxy for the market returns. The study shows that the performance of the Indian banks as measured by EVA is not very satisfactory. The results of the study reveal that the commercial banks under consideration have not created any positive EVA. The study indicates two possible reasons for the creation of inadequate positive EVA:

(a) Banks could be over capitalized and 6tygtfv

(b) Returns are very poor from banking business.

It also suggests that banks should improve and strengthen their credit assessment technique and monitoring mechanism to bring down the non-performing assets so as to improve the earning capacity.

D. Observations from Different Research Studies:

The foregoing review and extractions of some representative studies from the ongoing researches suggest that EVA research is a quite popular subject in the current financial research. The review gives rise to the following major observations:

Several new management accounting and decision tools have been developed in recent years both in business and consulting practice and research. Of them all, perhaps the EVA has attracted the highest attention.

The studies collectively contribute significantly in enriching our understanding on various conceptual and application dimensions. Studies not only bring to light the soundness, strengths and scope for wider application of the tool but also the drawbacks and inherent complexities both the conceptual and in applications.

The leading researches in EVA world over have extended to very wide range of applications. The efforts begin with enriching the concept as a tool in general for strategic and other decisions, and go up to its utility under specific situations or for different industries and typical problem areas, for example, EVA for banks: value creations, risk management and profitability measure.

Integration of EVA with order modern tools of management for enhanced Mutual capabilities such an activity based cost management and the EVA. Some initial efforts of this kind have begun to appear in Indian context also. We find that in methodological terms also the EVA research offers a wide scope. Methodologically the studies have come from simplest ones to depending on sophisticated techniques.

The EVA research has called upon with greater emphasis than ever before for disciplines of accounting and finance management, economics and mathematics and statistics to come in partnership for research. Undoubtedly, some of the researches in EVA in India are quite sound and have unearthed the revealing facts. Of course, they are mostly from premier institutions, like IIMs and IITs. Both the university departments and bodies and persons including executives and consulting services in India have shown little interest as compared to their counterparts abroad. The EVA research so far in India has not been as much varied in terms of the conceptual and application issues involved as well as the methodologies adopted. Evidences, on the trend of inter-disciplinary efforts are yet to be witnessed in India.

Chapter-3:The Analysis

For the purpose of better and in-depth study, ten companies from two major industries which are the most growing and having importance for economic growth for the country have been selected. The study will also help to make inter firm and intra firm comparison.

Companies under Study at a Glance

Abbildung in dieser Leseprobe nicht enthalten

For the purpose of comparison between traditional performance techniques and Economic Value Added technique, the following parameters have been used for performance evaluation: -

B= bad (negative value)

A= Average (upto 5%)

S= Satisfactory (5% to 10%)

G= Good (10% to 15%)

VG= very good (More than15%)

In case of EPS

B= bad (negative value)

A= Average (upto Rs. 5)

S= Satisfactory (Rs. 5 to Rs. 10)

G= Good (Rs. 10 to Rs. 15)

VG= very good (More than Rs. 15)

For a better and vast study the study has been carried out from the following angles as under: -

1. Performance Appraisal of the Individual Company

2. Intra Industry Performance Appraisal on the basis of Individual Performance Parameter

I. Performance Appraisal of Individual Company

A. Steel Industry

1. JSW Steel Limited (Refer Table: 01-05)

Performance of the company has been analyzed by using a number of performance measures as under:

A. Traditional Performance Measures:

1. Value Added Analysis (VAA): - Sales of the company has been increased at a very tremendous rate, it was Rs. 3,27,396 lacs in 2003-04 which almost doubled in 2004-05 i.e Rs. 6,67,936 lacs. The sales decreased to Rs. 6,18,010 in 2005-06 but again increased to Rs. 8,55,436 lacs in 2006-07. In the year 2007-08, the sales further increased to Rs. 11,42,000. After 2005-06, there has been continuous increase in the sales.

Company has added Value Rs 80,122 lacs in 2003-04 which increased to Rs. 2,05,628 lacs in 2004-05 but reduced to Rs. 1,34,155 Lacs in 2005-06. After 2005-06, value added increased tremendously. In 2006-07 it increased to Rs. 2,53,774 and further increased to Rs. 2,75,891 lacs in 2007-08. If we further analyze it can be observed that:-

a. The company has added the highest value 30.79% of sales in 2004-05 while the same was found lowest in 2005-06 at 21.71%. There has been increase in sales revenue in 2006-07 and 2007-08, but value addition reduced due to large portion of Revenue consumed by raw material & services used.
b. Company has added the highest value at 48.23% in 2004-05 of material cost while the same was found lowest at 30.26% in the year 2005-06.
c. Company added value to net worth at an average 45.33% which was highest at 65.28% in the year 2004-05 & the lowest in the year 2005-06 at 30.80%.
d. Company has added value to capital employed on an average 20.61%
e. Company has added Rs.110.65 value to per share on an average while the face value of each share was Rs. 10. The company has been adding good percentage of value addition as compared to the face value of the shares.

[...]

Excerpt out of 186 pages

Details

Title
Performance Measurement: A Comparative Study of EVA and Traditional Performance Measurement Techniques
Subtitle
A Case Study of Steel and Petrochemicals Industry in India
College
Post Graduate Government College  (PGGC-46, Chandigarh)
Course
Commerce
Author
Year
2011
Pages
186
Catalog Number
V184720
ISBN (eBook)
9783656096207
ISBN (Book)
9783656096474
File size
1883 KB
Language
English
Notes
This research has proved that EVA is better tool of performance measurement as compared to traditional techniques. The research has been left opened on REVA. This can be further analyzed by the researchers...I am highly obliged to near and dear ones for their support and cooperation.
Tags
performance, measurement, comparative, study, traditional, techniques, case, steel, petrochemicals, industry, india
Quote paper
Dr. Shivani Gupta (Author), 2011, Performance Measurement: A Comparative Study of EVA and Traditional Performance Measurement Techniques, Munich, GRIN Verlag, https://www.grin.com/document/184720

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