Economic Value Added (EVA)

Economic Value Added (EVA) is a concept of excess profit and therefore measures the amount by which, expressed in money, the economic success of a year has exceeded the cost of capital.

At the same time, the abbreviation for Economic Value Added describes a consulting tool from the consulting firm Stern Stewart Co. and is registered as a trademark in the USA. This consulting tool is EVA
1. characterized by various concretizations in the conversions,

2. With the concept of Market-Value-Added (MVA) expanded and developed into a teaching of value creation in the company

3. Enriched with a bonus system that links the bonus to the EVA from previous years.

Das ökonomische Konzept Economic-Value-Added ist also zunächst eine Variante des Übergewinns (Added value) andere Übergewinnkonzepte sind der Added-Value, der Economic-Profit und der Cash-Value-Added (CVA) und als solcher ist EVA ein Begriff der Wissenschaft und kein kommerzielles Produkt mit eingetragenem Markennamen.
In order to determine the economic success, EVA uses the accounting data as a basis (accounting model) and modifies it with conversions.

The EVA value is to be understood as the difference between the “economic profit for the benefit of all investors” and the total cost of capital. The "profit for the benefit of all investors" is initially the sum of profit and interest expense. In order to obtain an "economic profit for the benefit of all investors", those expense items that reduce the profit must be "activated" retrospectively, provided that they can be viewed as investments and therefore represent a use of profit, as it were. This includes in particular the expenditure with an investment character, above all wages and other expenditure for research and development.

EVA = Gewinn + Zins + Investivaufwand Gesamtkapital * Cost of capital

The "economic profit for the benefit of all investors" is then compared with the expected result, and that equates to the total capital employed multiplied by the market rate of return (cost of capital).

Here the market value of the capital is actually to be assumed, i.e. the total value of the company, if only because the cost of capital is understood as a market value. It goes without saying, however, that shareholders (including existing shareholders) decide every trading day whether they should sell the share or not. If you keep the share, you decide to continue using capital in the amount of the market value.

The just defined added value has not been given the designation EAV and was called EVA in order to be more attractive as a consulting tool. In fact, almost all publications refer to the consulting company's EVA consulting tool.

EVA is based on NOPAT (Net Operating Profit After Taxes), i.e. the operating result less taxes. This variable is modified with various conversions so that it gains the desired economic significance. According to Stern Stewart Co., 164 conversions are possible, but in practice five to ten adjustments are made; here a balance between accuracy and simplicity is sought. However, the few important adjustments differ from industry to industry. Some industries are therefore trying to standardize conversions so that companies' EVA bills can be compared.

The total cost of capital is then determined. At EVA, the operating assets NOA (Net Operating Assets) are assumed, and this figure is multiplied by the average cost of capital to be used for debt capital and equity. The following therefore applies to EVA:

EVA = NOPAT + conversion, +… + conversion NOA * cost of capital

EVA and REVA

The consulting firm Stern Stewart & Company evaluates the assets tied up in the business using the accounting model, which means that the return claim of the investor relates only to the book values. Because the market values are usually higher than the book values, EVA tends to show the outperformance too high, which of course suits the management very well.

Accordingly, other authors had reconsidered the original idea of excess profit in a modification of the EVA rather special calculation method. Various publications propose under the term REVA (Refined Economic Value Added) to relate the cost of capital to the market value of the capital employed. Of course, it is then more difficult for management to show an outperformance.

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