Economic Value Added – EVA
In respect to the corporate finance, EVA (Economic Value Added) is basically the estimation of the organization or firm’s profit in economic terms. Economic terms refer to value established in surplus amount of required return of the shareholders of the firm or company. However, economic value added is the firm’s profit earned less in comparison to the cost of financing the capital of firm. In accordance with the corporate finance and working capital management, the company’s shareholders have the advantage when return obtained from employed capital is far greater than the cost of that very capital.
Economic value added is NOPAT or Net Operating Profit after Taxes minus the capital’s money cost. In fact, the values of the company’s employees or product consumers are not included whole making calculations. The formula for estimation of EVA is:
EVA = (r-c)*K = NOPAT-c*K
Where,
r = (NOPAT/K) , which is ROIC or Return on Invested Capital
c refers to the WACC or Weighted Average Cost of Capital
K represents capital employed
NOPAT refers to the Net Operating Profit After Tax, along with necessary adjustments and translations for payment of goodwill, capitalization of advertizing brands and others.
The fiscal performance measurement on the basis of operating income ( but after taxes), also investment made in assets so as to produce income and the money invested in assets determines the EVA. The operating income after tax, assets investment and capital cost helps in calculating the EVA. Economic value added is dollar amount and if it is positive that ensures company is now wealthy or it has gained operating income after tax more than assets cost employed to produce that very income. However, if the EVA is negative, that means instead of establishing wealth, company is eating capital. Therefore, the aim of the company lays on establishing positive EVA and it shall keep on increasing.
Written by: Matt
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