Impacts of Economic Value Added in Business

Impacts of Economic Value Added in Business

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Introduction

The financial performance of any company is measured through Economic Value Added statements (EVA) in order to ensure effective management of the operations of a company (Grant, 2003). The calculations and measurements in financial matters are also used to determine and guide the set economic strategies by the company as well as ensuring that the incentives to be provided to the employees are verified through EVA statements. The article looks into how financial reporting, results and success of a company is determined and improved through EVA statements (Fitz-enz, 2000).

Importance Economic Value Added Statements in Financial Reporting

One of the most imperative tools in assessing a company’s financial performance is the use of EVA as a reliable metric system in financial status of a corporation. The amount that a company is earning is measured in dollars after the cost of capital is deducted; therefore, the flow of generated capital and the use of acquired capital is well-analyzed through EVA (Grant, 2003). The EVA economic theory was introduced by Stern Seward and it has been effectively used in financial evaluation for many years now as it has high reliability. It is the best platform to ensure that managers are held accountable for the way capital is spent in an organization through evaluation of income statements, balance sheets or any other financial statements. Moreover, EVA consolidates all the financial transactions into a single document for easy analysis on accountability of each and every dollar (Salmi & Virtanen, 2001).

In addition, EVA has another advantage in that it improves the financial reporting as the wealth accumulation for investors is accounted for and responsibilities on how money was spent are identified. As a result, the share holder value is increased as time wastage in increment of EVA is mitigated (Savarese, 2000). Moreover, EVA is very important in corporations as through it, verbal communication and financial statements are improved in the making of long-term decisions in regards to the corporation’s financial status. The company’s capital is not included in EVA and therefore, profit is only determine after the deduction of all costs inclusive of the capital raised; therefore, EVA can be described as the subtraction of all costs including capital from the net operating profit (Salmi & Virtanen, 2001).

In addition, when it comes to employee’s interests, EVA is able to tie them to those of the investors in that the EVA metric ties their compensation to the output enabling the employees to be paid for the improvements they have made to the organizations. The company is also able to change its financial spending and behaviour after understanding the factors that influence EVA and economic returns (Fitz-enz, 2000). Moreover, EVA cannot be manipulated as they have strict and reliable objective measure in performance. The EVA plan is also simple in comprehension thus enabling financial managers assess the spending of the company. The method also allocates a significant bonus to the employees depending on their performance for the company. In addition, the target for the company is kept fixed without any waiver from the target after plans have been set (Savarese, 2000).

Disadvantages of EVA in Corporations

When it comes to opportunities for growth, EVA does not accommodate the opportunities and the real options involved when investment decisions are being made, this is to mean that it is hard to evaluate the market value of a corporation’s growth opportunities as it accounts for current profits realized by corporations and accounting only for how it was used (Fitz-enz, 2000). The only way to make EVA substantial in growth prediction and opportunities is re-combining it with Market Value Analysis (MVA) otherwise it cannot be used for the prediction on its own. On the other hand, the implementation of the EVA process is costly and timely measure that requires serious commitment. The corporation or company has to invest heavily on the training of the EVA personnel as well as the establishment of an effective communication channel within the company (Savarese, 2000).

Conclusion

EVA is a very effective channel in determining the performance of a company as well as fostering accountability in the way money is spent in an organization. In addition, it is a reliable way to determine the company’s profit realization (Salmi & Virtanen, 2001). However, as effective as the method is, it cannot be relied on when it comes to determination of the company’s growth in future as it cannot be used independently without the incorporation of MVA. It is also a costly measure and therefore making it affordable by well established organizations and companies only as the small businesses and middle-class companies cannot afford the high costs (Grant, 2003).

References

Fitz-enz, J. (2000). The ROI of human capital: Measuring the economic value of employee performance. New York: AMACOM.

Grant, J. L. (2003). Foundations of economic value added. Hoboken, NJ: J. Wiley.

Savarese, C. (2000). Economic value added: The practitioner’s guide to a measurement and management framework. Warriewood, N.S.W: Business + Pub.

Salmi, T., & Virtanen, I. (2001). Economic value added: a simulation analysis of the trendy, owner-oriented management tool. Vaasa: Universitas Wasaensis.