Economic Value Added (EVA) Accounting Practice
Although Economic Value Added (EVA) is not a new concept in economics and financial theory and is based on the 19th century concept of "economic profit," it has only been widely adopted recently by business firms as an accounting practice. In this paper we shall describe what EVA is, and look at its pros and cons from the point-of-view of the company adopting the practice and the investors. We shall also discuss how EVA differs from some other emerging accounting practices and the major issues relating to EVA as compared to other commonly used accounting principles. Finally, the possible problems and opportunities that a company adopting EVA principles can face shall be examined.
What is Economic Value Added (EVA)?
Economic Value Added (EVA) is the after-tax cash flow generated by a business minus the cost of the capital it has invested to generate that cash flow. It represents the "real" profits rather than the "paper" profits that a business earns and is increasingly in corporate finance for business planning and performance monitoring. (Keen, 1999)
In other words Economic Value Added is not the straightforward accounting "profit" that we get by subtracting the costs minus revenue. In EVA we take into account the "cost of capital" that is invested in the business and the cost of capital includes both debt and equity. Hence if we invest, for example, $100,000 in a business and get $110,000 as revenue the profit is not simply ($110,000 minus $100,000 = $10,000) since the $100,000 at the time of investment had an opportunity cost that has to be accounted for before we determine our "real" profit. If the opportunity cost of $100,000 at the time of investment was $120,000, i.e., the investor could earn $20,000 by investing his/her money elsewhere, the $10,000 "paper profit" would actually be a "loss" in real terms.
EVA is also a proprietary trademark of Stern Stewart & Co., a global consulting company.
Pros and Cons of EVA-Shareholders' &...
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