Economic value added (EVA)

What it means

Economic value added, or EVA, measures whether a company earns more than the capital it uses costs. It is calculated as NOPAT, net operating profit after tax, minus a capital charge obtained by multiplying invested capital by its average cost, the WACC.

The key point is that EVA includes the cost of equity, which the accounts do not show. Accounting profit is after interest on loans but not after the return the owners expect. A company with a positive profit can have negative EVA if its owners could earn more elsewhere for the same risk.

Positive EVA means the company creates value for its owners, negative EVA that it destroys it. Comparing ROIC with WACC leads to the same conclusion: if the return on invested capital exceeds its cost, EVA is positive.

How it works in practice

In practice EVA is used mainly in larger companies and groups to assess divisions and projects, and sometimes to reward management. It motivates managers not only to raise profit but to use capital sparingly, meaning not to grow inventory, receivables or assets without an adequate return.

For smaller companies EVA is useful as a way of thinking. When deciding on an investment, it is worth asking whether a new machine or branch will return more than the cost of money, including what the owner could earn elsewhere. In a business valuation, the sum of future EVAs relates to how much the company is worth above its book value.

The calculation requires adjustments to accounting figures: for example, some research or marketing costs are treated as investment rather than expense, and leases are added to capital. Each time it is used, the adjustments should be clearly documented so the figures remain comparable over time.

What to watch out for

EVA is sensitive to the estimate of WACC, especially the cost of equity, which cannot be read from the market for a private company. A small change in assumptions can turn positive EVA negative. It is therefore better to track its trend and compare divisions than to focus on the absolute figure.

When pay is tied to EVA, managers may postpone necessary investments, because they raise capital and lower EVA in the short term. To avoid long-term harm, EVA is best combined with other goals and assessed over several years.