economic value added

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Economic value added (EVA)

A method of performance evaluation that adjusts accounting performance for investors' required return on investment. Suppose a division produces a 12% return on capital invested. Given the risk of the division's business line, if investors would usually require 14% on capital invested for this level of risk, the division destroyed shareholder value by the EVA metric. This Stern-Stewart has a trade mark on this term.

Economic Value Added

A company's after-tax earnings less its opportunity cost. The economic value-added measure is a metric of how well it has performed over a given period of time compared to how it could have performed.

economic value added (EVA)

a measure of a firm's overall profit (loss) position when allowance is made for the OPPORTUNITY/ECONOMIC COSTS of the firm's capital (that is, the revenues the firm's assets could have earned in some alternative use). Whereas accounting PROFIT = SALES REVENUE less accounting COSTS (see PROFIT AND LOSS ACCOUNT), EVA = sales revenue less accounting cost less opportunity economic costs.

To illustrate: assume sales revenue is £1,000,000 and accounting cost is £900,000; on conventional criteria the firm thus makes an accounting profit of £100,000. However, when allowance is made for the opportunity cost of the firm's assets if liquidated and redeployed in an alternative use the picture changes. If the firm's assets could have earned, say, £200,000 in some alternative activity (e.g. even putting the money on interest-bearing deposit with a bank) then the positive accounting profit is turned into an economic loss of £100,000. Thus, shareholders' wealth has been ‘destroyed’ rather than ‘created’.

However, whilst producing accurate accounting cost and profit data can be difficult, obtaining reliable economic cost and profit data can be even more problematic. For example, a high proportion of the investment in the firm's current activity may represent a ‘sunk’ cost with little prospect of recovery if liquidated, while there is a difficulty in identifying which are likely to be viable alternative activities where the firm's new investment might yield higher profit returns than currently being achieved.

References in periodicals archive ?
EVA Airways began operations in 1991 and is now one of the fastest growing airlines in Asia.
Advocates claim that use of the EVA measure helps managers make better decisions by motivating them (through compensation schemes tied to the metric) to focus their efforts on value creating activities.
She said it was vital to raise funds for EVA so it could continue its service offering women and children emotional and practical support.
EVA Airline is honored to cooperate with NCKU," said EVA President Cheng who added that the program for civil aviation engineering is hands-on-oriented and interdisciplinary when NCKU takes the theory teaching and EVA Air takes the training.
The 777-300ERs will be configured with 333 seats in three cabins, 39 in the luxurious new Royal Laurel Class business, 56 in Elite premium economy and 238 in Economy, EVA said adding that as the new 77-300ERs are placed in operation, the airline will increase flight frequencies on busy routes and replace the older aircraft on long-haul flights to North America and Europe.
Herman Miller, the second-largest office furniture maker in the United States, overcomes some of the shortcomings of GAAP by following the EVA methodology developed by the consulting firm Stern Stewart.
For the scientist, it is perhaps tempting to view EVA as simply one more in a long series of financial metrics.
Whatever his motives, his premature announcement was for a time a body blow to the EVA implementation that had been underway for six months; in another three months, the EVA incentive system was supposed to go into effect.
This analysis offers a new definition of value, and suggests that the missing link in the EVA process is productivity, generally found to be the engine of all economic growth.