"Economic Value Added - (EVA)" (1)
ECONOMIC VALUE-ADDED: BEYOND PAPER PROFITS
This commonsensical idea is formalized in the relatively new mainstream
of corporate finance called economic value-added (EVA). Quite simply, EVA
is the after-tax cash flow a firm derives from its invested capital less
the cost of that capital. EVA represents what Warren Buffet calls
"owners' earnings," as opposed to paper profits. A key finding
of the theorists who developed EVA is that reported profits and earnings
per share do not correlate to shareholder value (in terms of the total
market value of the firm), but EVA does-strongly. Peter Drucker, so often
among the first to articulate important new business ideas, asserts
bluntly that when a firm consistently falls to generate after-tax cash
flow larger than the cost of the capital provided by its shareholders, it
destroys both its capital and shareholder value.
An article in Fortune makes explicit the connection between intangibles
such as processes and EVA:
"How much capital is tied up in your operations? Even if you don't know
the answer, you know what it consists of: what you paid for real estate,
machines, vehicles and the like, plus working capital. But proponents of
EVA say there's more. What about the money your company spends on R&D?
On employee training? Those are investments meant to pay off for years,
but accounting rules say you can't treat them that way; you have to call
them expenses, like the amounts you spend on electricity. EVA proponents
say forget the accounting rules. For internal purposes, call these things
what they are: capital investments. No one can say what their useful life
is, so make your best guess-say five years. It's truer than calling them
expenses."
Because business processes are a substantial, though largely hidden
part of a firm's total capital, EVA is an essential tool for business
process investment; it is the only way to determine whether a particular
process is an asset or a liability. Some of the companies I discuss
later-notably, PepsiCo, Inc., CSX, and AT&T Corp.-report major
improvements in resource allocation to processes as a direct result of
adopting EVA.
(1) The Process Edge - Creating Value Where It Counts
- Peter G.W. Keen
- page 20-21
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