Economic Value Added EVA
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IGC-DEFINITION (abbreviated)
Economic Value Added EVA
Economic Value Added is a profitability figure that shows the shareholders, if the management was able to create value during a given period. Primarily, the EVA-concept should lead to higher profitability for the shareholders, but it is also a performance measure for managers.
EVA is intended to overcome the short-term scope of profitability figures like ROI, usually measured on a yearly basis. Managers who invest in the future of the company get lower ROI-percentages in the short run because they have more depreciation and more fixed costs to carry.
Value is created when the difference between realised profitability and the market-oriented cost of capital is positive.
The calculation of capital costs is the same as with shareholder value using the WACC-formula (WACC = Weighted Average Cost of Capital) as a market-orientated interest rate.
The relevant profit figure is profit after taxes but before deduction of interest. To take investments in the future of the company into consideration, expense for research & development, marketing and product introduction is added to the above profit figure and then written off over several years. The resulting depreciation is then deducted from the profit figure. This leads to a higher profit volume, which in turn leads to a higher tax volume.
The following formula is the result:
EVA can thus also be described as the surplus profit over the WACC demanded by the capital market.
The net operating assets are also corrected, starting from the balance sheet total. First, the liabilities for which no interest is paid (mainly accounts payable) are deducted. The resulting figure is the capital employed. Then the value of the not yet depreciated expense for research & development, marketing and product introduction is added to the working capital.
from: IGC-Controller-Wörterbuch, International Group of Controlling (Hrsg.)
