See Also:
Activity Based Management
Capital Structure Management
How to collect accounts receivable
How to manage inventory
Why Exit Planning
Economic Value Added Definition
Economic value added (EVA) measures the effects of managerial actions. It also focuses on managerial effectiveness in a given year.
Economic Value Added Formula
Use the following formulas to calculate the EVA:
EVA = Operating profit after taxes – Cost of all capital
Or = (Sales revenue – operating costs –taxes) – (total capital supplied * cost of capital)
Economic Value Added Calculation
For example, a company has $10,000 in operating profit, $50,000 in debt and weighted average cost of capital of 10%. The economic value added calculation can be found below:
EVA = 10,000 – (50,000 * 10%) = 5,000
Applications
EVA is an estimate of a company’s true economic profit for the year. But it differs substantially from accounting profit. It depends on both operating efficiency and balance sheet management. Furthermore, without operating efficiency, operating profits will be low. In addition, without efficient balance sheet management, there will be too many assets, hence too much capital. In conclusion, it results in higher-than necessary capital costs.
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