Economic value added

In corporate finance, economic value added (EVA) is an estimate of a firm's economic profit, or the value created in excess of the required return of the company's shareholders. Quite simply, EVA is the net profit less the equity cost of the firm's capital. The idea is that value is created when the return on the firm's economic capital employed exceeds the cost of that capital. This amount can be determined by making adjustments to GAAP accounting. There are potentially over 160 adjustments but in practice only several key ones are made, depending on the company and its industry. EVA is a service mark of Stern Value Management.

EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the product of the cost of capital and the economic capital. The basic formula is:

where:

EVA calculation:

EVA = net operating profit after taxes – a capital charge [the residual income method]

therefore EVA = NOPAT – (c × capital), or alternatively

where

NOPAT is profits derived from a company’s operations after cash taxes but before financing costs and non-cash bookkeeping entries. It is the total pool of profits available to provide a cash return to those who provide capital to the firm.

Capital is the amount of cash invested in the business, net of depreciation. It can be calculated as the sum of interest-bearing debt and equity or as the sum of net assets less non-interest-bearing current liabilities (NIBCLs).

The capital charge is the cash flow required to compensate investors for the riskiness of the business given the amount of economic capital invested.

The cost of capital is the minimum rate of return on capital required to compensate investors (debt and equity) for bearing risk, their opportunity cost.

Another perspective on EVA can be gained by looking at a firm’s return on net assets (RONA). RONA is a ratio that is calculated by dividing a firm’s NOPAT by the amount of capital it employs (RONA = NOPAT/Capital) after making the necessary adjustments of the data reported by a conventional financial accounting system.

...
Wikipedia