In the past, key financial instruments were focusing on concepts like the return on investment, return on equity and return on capital employed. However, within recent years, the flaws of the named ratios made it difficult to thoroughly rely on such figures any longer. As one key drawback connected to those solely finance-related ratios was that all non-financial aspects are missed out on. Further, the economic value creation was not respected in past models. EVA®, economic value added, is a concept on the rise that counteracts the flaws of recent financial ratios. By accounting for both the capital charges for investors and creditors, it allows a more sophisticated look into the value creation of a company. However Stern Steward & Co, who founded EVA®, give recommendations, so called adjustments, in order to make EVA® even more effective as it is without. As economic decision are not only covered by introducing a new ratio, it is important to contrast and to integrated EVA® to other frequently used financial models. Here, the net present value calculation is used most when evaluating on whether or not to take on a project. Now, the author shows that EVA® even can be used for net present value calculations, which is usually done by taking into consideration future cash flows. Further, economic profit is not all a modern business has to care about. In this respect, cash management has evolved in becoming a crucial cornerstone in financial management. Hence, the author has compared the cash conversion cycle to the EVA®. The questions is, does liquidity also affect the EVA® result? Finally, the author concludes on whether or not EVA® can be regarded as ‘the one financial ratio’ an how it interplays with other important models used in modern companies.
Table of Contents
1. INTRODUCTION
2. EVA – THE ONE PROFIT FIGURE
2.1 CALCULATION OF ECONOMIC VALUE ADDED
2.2 THE BENEFITS AND DRAWBACKS OF EVA®
2.2.1 Benefits of applying EVA®
2.2.2 Pitfalls of applying EVA®
3. THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND DISCOUNTED CASHFLOW MODEL
4. THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND CASH CONVERSION CYCLE
5. CONCLUSION
6. REFERENCE LIST
Objectives and Topics
This work aims to evaluate Economic Value Added (EVA®) as a sophisticated performance measure compared to traditional accounting-based metrics and to explore its relationship with project valuation models and liquidity management strategies.
- Evolution of financial performance measures from ROI to EVA®
- Technical calculation and necessary adjustments of the EVA® model
- Integration of EVA® into Net Present Value (NPV) decision-making
- Analysis of the correlation between EVA® and the Cash Conversion Cycle (CCC)
Excerpt from the book
2.1 CALCULATION OF ECONOMIC VALUE ADDED
EVA® in essence can be defined as the difference between the net operating profit after taxes and the cost of invested capital. Here, multiple financial terms are used to describe the same calculation. In the following, the author will refer to NOPAT as being the net operating profit after tax and the capital charges being weighted average cost of capital (WACC) multiplied with the capital employed (CE). Hence, the formula of the EVA® after tax calculation can be stated as:
(1) EVA® after tax = NOPAT – Capital charges after tax
The capital charges can be further broken down into:
(2) Capital charges = WACC x CE
In order to ensure a common understanding of the calculation, the author further aims to break down WACC to enhance the level of detail on what influences the EVA® result in the end (Young & O'Byrne, 2000).
Summary of Chapters
1. INTRODUCTION: This chapter reviews the shift from traditional financial measures like EPS and ROE toward Economic Value Added as a superior performance criterion that accounts for risk and the cost of equity.
2. EVA – THE ONE PROFIT FIGURE: This section details the calculation method for EVA®, including its core components NOPAT and WACC, while discussing the strategic benefits and the necessary adjustments required to mitigate pitfalls like depreciation and accounting arbitrary.
3. THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND DISCOUNTED CASHFLOW MODEL: The chapter demonstrates that valuation via the EVA® model yields equivalent results to discounted cash flow models, establishing EVA® as a robust tool for project selection and value creation analysis.
4. THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND CASH CONVERSION CYCLE: This part examines the statistical link between liquidity management and profitability, suggesting that higher liquidity, indicated by a decreasing Cash Conversion Cycle, positively influences the EVA® result.
5. CONCLUSION: The author concludes that while EVA® is a powerful management tool that aligns employee incentives and improves working capital monitoring, its success relies on rigorous communication and appropriate adjustments.
6. REFERENCE LIST: Provides the comprehensive list of academic sources and industry reports used to substantiate the arguments throughout the document.
Keywords
Economic Value Added, EVA, Financial Ratios, NOPAT, WACC, Capital Employed, Cash Conversion Cycle, CCC, Net Present Value, NPV, Liquidity Management, Performance Measurement, Value Creation, Investment Decisions, Working Capital.
Frequently Asked Questions
What is the primary focus of this publication?
This work provides a detailed walkthrough of the Economic Value Added (EVA®) concept, assessing its efficacy as a performance measure and its relationship with other vital financial metrics.
What are the core financial themes discussed?
The publication covers value-based management, corporate performance evaluation, liquidity management, project valuation, and the integration of diverse financial models.
What is the central research question?
The author explores whether EVA® can be considered an all-encompassing financial ratio and how it interacts with NPV calculations and the Cash Conversion Cycle.
Which scientific methodology is applied?
The author uses a literature-based analytical approach, contrasting traditional accounting measures with value-based metrics and deriving mathematical relationships between EVA®, NPV, and CCC.
What does the main body cover?
It covers the calculation mechanics of EVA®, the benefits and drawbacks of the model, its mathematical link to discounted cash flows, and its correlation with operational liquidity.
What are the key terms characterizing this work?
The work is defined by terms such as Economic Value Added, WACC, NOPAT, Cash Conversion Cycle, and value-based management.
How does the author address the problem of depreciation in EVA®?
The author notes that without adjustments, depreciation can inflate EVA® results; therefore, he recommends using average capital employed figures and specific amortisation methods to ensure accurate management incentives.
Why is the connection between EVA® and the Cash Conversion Cycle important?
This connection is vital because it links long-term value creation (EVA®) with short-term operational efficiency (CCC), providing a more holistic view of business health.
Does the author believe EVA® is the ultimate performance tool?
The author suggests that while EVA® is powerful, it is most effective when combined with other measures like the Cash Conversion Cycle, as there is no single "ultimate" tool for all business scenarios.
- Citar trabajo
- Cornelius Kirsche (Autor), 2013, Economic Value Added: A Detailed Walkthrough, Múnich, GRIN Verlag, https://www.grin.com/document/209726
