The Strengths, Weaknesses and Uses of the Economic Value Added (EVA) Essay

The Strengths, Weaknesses and Uses of the Economic Value Added (EVA) Mode - Essay Example Economic Value Added (EVA) EVA is a relatively new technique of measuring financial performance of companies. This tool relies on three basic elements which are Net Operating Income adjusted after taxes (NOPAT), the investment amount and the weighted average cost of capital (Hansen & Mowen, 1997). EVA can be calculated as: EVA = After tax operating income – (investment in assets x weighted average cost of capital) The amount calculated under EVA is an absolute dollar amount. The amount calculated can be either have a positive value or can have negative value. The positive value shows that the organization has remained successful in generating more Net Operating Income After Tax (NOPAT), well covering the cost of investments that were employed. On the other hand, negative values shows organization’s failure in recovering the costs of investment as its cost of investments exceeded the Net Operating Income After Tax (NOPAT). Obtaining the positive value of EVA is the core objective of any organization. Strengths of EVA EVA has significant strengths which have increased its popularity tremendously. In the following discussion, more attention will paid on different aspects of EVA. 1. Better Measure EVA has turned out to be a better measure in terms of performance measurement of different stakeholders in organizations. ... In order to achieve personal and individual goals, the broad objectives and goals of organization are put aside courtesy this technique. However, EVA is the technique which measures the performance of financial managers in an absolute dollar amount. This technique explains the absolute value added by the financial managers to their divisions and the organization as a whole. So the financial managers try to increase the EVA in comparison with other financial mangers to exceed the amount of EVA as much as they can, this effort causes benefits to financial managers, their divisions and the overall organization. 2. Absolute Measure of Performance One of the most promising strengths of EVA is that is explains the amount of value added by the financial managers in an absolute dollar amount. Other techniques such ROI measures performance in relative percentage terms which is not a true reflection of the performance of financial managers. The reason behind the failure of relative measures is that they do not take into account the size of amounts on which they are based. There are likelihoods that a financial manager earning too much with a huge amount of investments behind him/her, yet he/she end with lower ROI as compared to that financial manager who is responsible for lower magnitude of amounts. As a result, the true performance cannot be reflected if relative measures are used. On the other hand, EVA exactly explains the specific dollar amount that is added to the organization as a whole. 3. Similar to NPV This technique is very much similar to that of Net Present Value technique. In finance, the NPV technique has the importance of