What Is Economic Value Added?

EVA (Economic Value Added) is the English abbreviation of Economic Value Added, which refers to the income after deducting the total capital cost including equity and debt from net operating profit after tax. The core is that capital investment has costs. Only when the company's profit is higher than its cost of capital (including the cost of equity and debt) will it create value for shareholders.

Economic value added

Economic value added provides better

Compared with other indicators for measuring business performance, economic value added (EVA) has two major characteristics: First, it eliminates all costs. EVA deducts not only the cost of claims, but also the cost of equity capital, just like accounting profits. The second is to eliminate the influence of accounting distortion as much as possible. Traditional evaluation indicators, such as accounting returns, have some degree of accounting distortion, thereby distorting the company's true operating performance. Economic Value Added (EVA) makes necessary adjustments to accounting information, eliminating the unreasonable accounting data caused by the traditional principle of soundness of accounting, making the adjusted data closer to cash flow, and better reflecting the true performance of the company. Therefore, economic value added (EVA) reflects the real business performance of the enterprise more realistically and objectively.

EVA cannot simply pursue the larger the better, but the larger the better under quality constraints. The quality of economic value added is mainly reflected in: structural quality, that is, the operating economic value added in the composition must account for more than 75%; input quality, that is, the invested capital must account for more than 65% of the total assets; and quality of efficiency, that is, the invested capital The greater the economic value added of the output, the more efficient it is; the quality of growth, that is, the current period is getting better and better than the previous period.

1.Corporate governance

Corporate governance refers to the definition of the fundamental purpose of the existence of the enterprise, setting the operator and owner (ie

EVA = Net operating profit after tax-Total capital cost

= Net operating profit after tax-capital ×

] EVA, FCFF, SVA, CFROIb]

In the current theory and practice of enterprise value assessment, the discounted free cash flow method of enterprises (hereinafter referred to as the FCFF valuation method) is the mainstream method. This method considers that the value of an enterprise is equal to the present value of the expected free cash flow of the enterprise discounted by the enterprise at an appropriate discount rate. The so-called free cash flow of the enterprise refers to the total after-tax cash flow generated by the operation of the enterprise, which can be provided to all suppliers of corporate capital, including creditors and shareholders. The free cash flow of the enterprise is equal to the difference between the net operating profit after tax for the current period and the newly added investment capital for the current period (the investment capital here is the same as above, after depreciation of fixed assets has been deducted), which is expressed by the formula:

F C F F t = N O P A T t I t

among them:

F C F F t free cash flow of the enterprise that can be obtained at the end of period t;

N O P A T t net operating profit after period t;

I t new investment capital in period t (= I t I t 1).

The EVA valuation method is superior to the FCFF valuation method in that EVA is an effective measure for understanding the company's operating conditions in any single year, but FCFF cannot. The FCFF valuation method is difficult to track and understand the company's investment capital during the operating period of the company by comparing actual and projected cash flows. Any arbitrary investment in fixed assets and working capital in one year will affect cash flow and discounted value. Management It is easy for investors to postpone investment just to improve the cash flow of a certain year, so that the long-term value creation of the enterprise suffers. The EVA valuation method does not consider the size of the annual capital investment amount before and after. It only determines the estimated EVA for a single period, and can be compared with the actual EVA to analyze this deficiency of the FCFF valuation method. The dual advantages of facilitating the evaluation of value effectiveness.

Common characteristics of SVA, EVA, CFROI:

First, they are calculated taking into account the opportunity cost of capital. This is also an important sign that distinguishes them from traditional performance evaluation indicators (such as EPS (earnings per share) and ROE (return on equity)). In the securities market where capital resources are scarce, the reason why shareholders invest capital in a particular company rather than other companies is because they believe that this company can bring them higher-than-social returns, and corporate returns. Only when the level is higher than the average level of social average returns, can it be said that it has created value for shareholders. Opportunity cost is a reflection of the general level of benefits. It can be described in the form of "absolute amount" or in the form of "discount rate". EVA uses the former, while SVA and CFROI use the latter. According to the value theory in financial economics, the two main factors that determine the value of an enterprise are the net cash flow and the level of risk. Traditional financial indicators only consider the former and not the latter, and therefore deviate from value. SVA , EVA, and CFROI do not have this problem, because these indicators take into account the impact of opportunity cost, while the opportunity cost and the "risk level" are essentially the same.

Second, they all try to influence the future by assessing history. These indicators are "backward", and their calculations are based on historical figures that have become facts. Enterprise value depends only on future returns and risks, and has nothing to do with the past. The significance of these indicators is that by measuring the past and linking the measurement results with the manager's salary, it can effectively affect the manager's behavior in future value creation, and thus influence the future value creation results by guiding the manager's behavior.

Third, the evaluation of these indicators is only meaningful in the long run. Value creation is a long-term, continuous process, and the results of these indicators in a single accounting period usually do not have substantial significance. Only by extending the calculation period to several years, or by comprehensively examining the results of a certain consecutive year, the value creation results can appear. Similarly, in order for managers to create more value for shareholders through these indicators, the method of linking managers' compensation with indicators must also be based on the long-term perspective. For example, the EVA-based manager incentive system generally takes 5 years as an evaluation cycle, and SVA is 3 years.

Fourth, their calculations are much more difficult than traditional indicators. The advantage of these indicators is that the opportunity cost is considered, but the cost of the computer is also a problem. For listed companies, financial theories such as the Capital Asset Pricing Model ( CAPM ) provide the possibility to calculate the cost of capital, but there is no generally accepted method for a large number of non-listed companies. How to calculate capital at the various business unit levels within an enterprise Costs have yet to be explored. Although the basic data required for the calculation of these indicators comes from the accounting report, the accounting data must be adjusted and revised. Individual adjustments are quite complicated and difficult to understand.