Definition
The indicator of residual earnings, net operating profits after taxes minus capital costs, is the measure of financial performance most closely linked to shareholder values.
In detail
Economic Value Added (EVA) is a financial metric that measures a company's true profitability, equal to net operating profit after tax minus the cost of capital. It addresses the issue of traditional profit metrics ignoring the cost of capital employed, prompting managers to focus on shareholder value creation. Unlike metrics such as ROI, EVA emphasizes residual income after deducting all capital costs. Typical outputs include EVA values and their variance analysis, used for investment decisions and performance evaluation.
Example in practice
In annual strategic planning, the company uses EVA to evaluate the performance of each business unit. One unit showed profit growth, but its EVA was negative because it consumed significant capital. Management adjusted investment strategy accordingly, redirecting resources to projects with positive EVA, thereby enhancing overall shareholder value.