What is the economic value added (EVA) calculator? As its name implies, this tool is designed to assist you in measuring economic value added. It’s one of the metrics that are used for the assessment of a company’s economic performance.
Economic value added (EVA) is used by investors when evaluating a capital investment in companies and comparing it to other investments. When we analyze the value made for shareholders, this calculation factors in capital efficiency and operating earnings of a company. That allows us to evaluate the real economic profit without relying on figures in balance sheets.
The EVA calculator can make it easier for you to estimate the value of an investment in your portfolio. This handy tool can also help you determine how efficiently the capital is used by a company when creating value. It is best to combine it with the profitability index calculator to make sure the potential investment profitability is assessed properly based on the net present value.
In this article, you can find out more about economic value and how this concept works in practice. You can also learn how EVA is calculated and why it is important. We will also cover the limitations of using economic value added. Ready? Let’s dive in!
What Is Economic Value Added (EVA)?
Economic value added, or EVA, is a metric that can reveal a company’s financial performance. It helps compare the net operating profit with the charge or expense of raising the capital. This charge or cost is associated with the expense the company incurs when paying ROCE (Return on capital employed) to shareholders or investors. When it comes to the net operating profit, we think of the profit left after deducting taxes, interest, COGS (cost of goods sold), and operating expenses.
Value-added activities are those that make a product or service more desirable or valuable. They also add to the cost of production, but they help to improve the quality of goods and services. Economic Value Added is a measure of the contribution of a particular industry to the overall economy.
What is the Difference between Economic Value Added and Economic Profit?
These two measures are often confused for one another. That’s why it is important to see what makes the difference between the economic value added (EVA) and economic profit. To help you understand it better, we will see how it works in reality.
Companies create value when making sufficient profit that’s higher than the cost of capital. As you may already know, the cost of capital is the rate at which a company pays for its own funds. It can be calculated by dividing the cost of debt by the total amount of debt. The cost of equity is calculated in a similar way, but by dividing the cost of equity by the total amount of equity.
The higher the cost of capital, the more expensive it is for a company to finance its operations and investments, which can lead to underinvestment in projects with a high ROI or lower investment in projects with a lower ROI. Companies that are highly leveraged are more sensitive to changes in interest rates and tend to have higher costs of capital because they need to pay back their debt quickly.
As we mentioned above, EVA is used by investors to find out how effectively a firm has been performing in comparison with other investments. Economic value added is also employed by company management to check if their capital is used in an efficient way. This refers to capital that has been raised with the goal of meeting the expectations of shareholders.
It is important to point out that the EVA concept is intended to go beyond accounting profit numbers, which is very superficial. Instead, it’s based on the real profitability occurring when the return generated by a company is greater than the return that financiers require.
Thus, when measuring performance by means of EVA, it is expected that the cost of capital will be lower than surplus returns. This makes the difference between EVA and other profit metrics or indicators. Cost of capital doesn’t matter and there are no accounting manipulations.
EVA Formula: How Is EVA Calculated?
Now that you are familiar with the economic value added, it’s time to learn how to calculate it. All you need to do is use the formula below:
EVA = NOPAT – (Invested capital * WACC)
In this formula, invested capital multiplied by WACC is actually the finance charge. It represents the lowest return that finance providers (shareholders or investors) require on the given capital.
- NOPAT – the net operating profit after tax. This data can be found on the income statements of companies. Alternatively, it can be calculated when assessing the company’s operating efficiency.
- Invested capital – Shareholders put money into lenders, equity, and bondholders; these funds are called invested capital.
- WACC – Weighted average cost of capital. It represents a company’s average cost of capital that’s generated from every source, including bonds, preferred stocks, and common stocks.
Example:
- Net Operating Profit After Tax: $700,000
- Invested Capital: $1,600,000
- Weighted Average Cost of Capital (WACC): 0.17
EVA = 700,000 – (1,600,000 * 0.17)
EVA = 700,000 – 272,000
EVA = $428,000
In our example, the economic value added (EVA) is $428,000. While it’s not hard to calculate it by hand, we recommend using the EVA calculator to make sure the results are correct. By the way, it will save you time.
Limitations and Importance of EVA
Lastly, we want to explain the limitations and importance of using this concept. Here’s why the economic value added (EVA) is important:
- This calculation can be used to identify how and where wealth is created.
- It makes sure the companies are concentrated on the creation of wealth by means of economic surplus, not through net income.
- All costs are considered.
- It indicates how profitable and efficient every project is.
- EVA plays an important role in assessing the managerial performance of businesses.
When it comes to limitations, you should keep in mind the following facts:
- EVA isn’t suitable for service companies (like software companies) that feature a lot of intangible assets.
- It depends largely on invested capital, so EVA doesn’t always indicate how efficient the smaller companies are, particularly the ones with higher ROI comparably.
- Calculations only apply to the measured investment period, so you should not rely on them for predicting future performances. Therefore, it’s not reliable for businesses interested in reorganizing their production or making substantial capital investments.