Economic Value Added, EVA, is another of those annoying acronyms accountants tend to use to confuse simple marketers. Therefore, it is a term marketers must understand if they are to hold their own in the boardroom.
EVA is a calculation used to measure the net cash flow from an asset, after taking into account the cost of the capital necessary to acquire that asset. It is often a part of a business case made to support a major investment or M&A proposition.
There are a couple of calculations that need to be made, all from the standard company accounts.
- The net cash flow is obvious, what comes in versus what goes out, as a result of deploying the asset.
- The cost of capital will be some combination of the cost of equity and the cost of necessary borrowings.
When the net cash flow is greater than the cost of capital, the asset is generating value. When it is less, it is destroying value.
The formula is simple: EVA = Net cash after tax – capital invested X the weighted cost of that capital.
The shortcomings of an EVA calculation are twofold:
- It is based on the past. The cost of capital yesterday is unlikely to be the same tomorrow. Interest rates bounce around, and the mix of debt and equity while not as volatile does change with circumstances.
- Increasingly business transactions are being done on the basis of intangibles. Costing the replacement value of intangibles, is a practise lacking discipline, consistency, and financial rigor.
Building a business case for an investment always requires deep consideration of the cash flow results of that investment. By definition, that requires a forecast of the future be done as the driver of that cash flow.
It is always easier to take the past and extrapolate, than to spend the time and energy building a strategic case for an investment. A strategic case requires that the relative costs and benefits of differing choices be articulated, in an environment of information scarcity. A much more demanding task than constructing a future that is the same as the past, and hoping that this time, it will be.
Header illustration by AI, in a few minutes.
