Economic Value Added (EVA)

Economic Value Added (EVA) is a financial metric that measures a company’s profitability by comparing its net operating profit to the amount of capital invested. It is also known as Economic Profit.

EVA was developed by Stern Stewart & Co., a consulting firm, as a tool for assessing a company’s financial performance beyond traditional measures such as net income or earnings per share. EVA provides a more comprehensive view of a company’s profitability, considering the cost of capital and the opportunity cost of investing in the business.

The formula for calculating EVA is as follows:

EVA = Net Operating Profit After Tax (NOPAT) – (Capital * Cost of Capital)

NOPAT is calculated by subtracting operating expenses, taxes, and a charge for the cost of capital from a company’s operating income. Capital refers to the total amount of money invested in the business, including equity and debt. The cost of capital is the rate of return that investors require to invest in the business.

If a company’s EVA is positive, it generates more profit than it would if it had invested its capital in a risk-free investment that yields the cost of capital. A negative EVA indicates that the company is not generating enough profit to cover its cost of capital and may not be creating value for its shareholders.

EVA is often used as a performance measure for senior executives and managers, as it provides a more comprehensive view of a company’s financial performance and helps to align financial goals with business objectives. It can also be used to assess the performance of different business units and evaluate potential investments or acquisitions.

Economic Value Added (EVA) can be used to evaluate the financial impact of IT investments and initiatives. By calculating the EVA of an IT project or investment, organizations can assess whether it is creating value for the company and generating a return on the capital invested.

For example, suppose a company is considering investing in a new IT system. In that case, it can calculate the EVA of the project by estimating the net operating profit after tax (NOPAT) that the system is expected to generate and subtracting the capital invested and the cost of capital. If the EVA is positive, the project is expected to create value for the company and is a sound investment. If the EVA is negative, the project may not be creating value, and the investment should be re-evaluated or reconsidered.

IT departments can also use EVA to prioritize IT projects and initiatives based on their expected financial impact. By comparing the EVA of different projects, organizations can identify which projects will likely generate the highest return on investment and focus their resources and efforts accordingly.

EVA can also be used to evaluate the performance of IT departments and their contribution to the organization’s overall financial performance. By calculating the EVA of the IT department, organizations can assess whether it is generating value for the company and identify areas for improvement or optimization.

EVA can be a valuable tool for IT strategy, helping organizations to evaluate the financial impact of IT investments and initiatives, prioritize projects based on their expected return on investment, and assess the performance of IT departments in creating value for the company.

The Economic Value Added (EVA) category in our CIO Reference Library is a curated collection of resources, articles, and insights focused on providing IT executives and other professionals with a comprehensive understanding of EVA and its application in measuring a company’s financial performance and value creation.

EVA is a financial performance metric that measures the actual economic profit generated by a company after deducting the cost of capital from its operating profit. EVA helps to measure a company’s financial performance by providing a more accurate picture of its value creation, taking into account the cost of capital and the opportunity cost of investment.

This category covers a wide range of topics related to EVA, including:

• Overview of EVA: This includes an introduction to EVA and its importance in measuring a company’s financial performance and value creation.
• Calculation of EVA: This includes an overview of the formula and methodology for calculating EVA, including the components of operating profit, cost of capital, and capital employed.
• Advantages of EVA: This includes an overview of the benefits of using EVA as a performance metric, such as its ability to align incentives, improve capital allocation, and provide a more accurate picture of value creation.
• EVA and IT investment: This includes an overview of how EVA can be used to evaluate the economic value of IT investments and assess their impact on a company’s financial performance.
• EVA and strategic planning: This includes an overview of how EVA can inform strategic planning and decision-making by providing insights into the economic value of different business initiatives and investment opportunities.

By exploring the EVA category, IT executives and other professionals can comprehensively understand EVA and its application in measuring a company’s financial performance and value creation. This knowledge can help organizations to make more informed decisions about their investments, improve their capital allocation, and ultimately create more value for their stakeholders.