8/6/2019 108_EVAandVAS_BatchB

1/3

Economic value added (EVA) and Value added statement

Swatanu Mohan Satpathy

Roll No. 108 Batch B

Value Added is the wealth generated by the entity through the collective efforts of capital

providers, management and employees.

Economic Value Added or EVAcan be considered as an indicator of a firm's economic profit.

It is the excess added to the profit after the consideration of shareholder s expected return.

Mathematically we can state that

EVA=(Rate of Return on Investment - Cost of capital) x Investment

Or

EVA = Net operating profit after tax Investment x Cost of capital

Net operating profit after tax is the profit that is generated from a companys all operations after

the reduction of taxes. It is the total earnings available to the investors of capital in the firm. It is

important to note that in this case the profit after tax does not consider the interest that is paid;

which means

Net operating profit after tax = Earnings before interest and Tax Tax

The total capital invested by the investors is termed as investment. Cost of capital is calculatedfrom any method of capital budgeting, the most widely used being the weighted average cost of

capital method.

EVA is a registered trademark of Stern Stewart & Company.

Value Added Statement is a financial statement which shows how much value (wealth) has

been created by an enterprise through utilization of its capacity, capital, manpower, and

other relevant resources, and how it is being allocated among thedifferent stakeholders (employees, lenders, shareholders, government, etc.) in an accounting

period. It also shows how much value has been retained by the firm.

No business organization works with a motive of charity. The shareholders do not invest in the

company if the company cannot give them the required return they wish to have. To facilitate

the investors to know about the companys stand that whether there is a good return or not, the

method of economic value added is essential.

http://www.businessdictionary.com/definition/value.htmlhttp://www.businessdictionary.com/definition/enterprise.htmlhttp://www.businessdictionary.com/definition/resource.htmlhttp://www.businessdictionary.com/definition/resource.htmlhttp://www.businessdictionary.com/definition/enterprise.htmlhttp://www.businessdictionary.com/definition/value.html

8/6/2019 108_EVAandVAS_BatchB

2/3

Steps to calculate Economic Value Added

Step 1. Calculation of Net operating profit after taxes(NOPAT)

Revenue - Cost of sales = Gross profit

Gross profit - Expenses + Other income = EBIT

EBIT - Operating tax = NOPAT

Step 2.Calculating Capital Charge

Capital Charge is the total cost that has to be incurred to raise capital through debt or equity.

Capital charge can also be explained as the cash flow required to compensate investors for the

riskiness of the business given the amount of capital invested. So we calculate the cost of

capital, mostly using the weighted average cost of capital method.

Step 3. Calculating EVA

EVA = NOPAT - Capital Charge

Example

Total Revenue Rs 5,00,000

Operating Expenses Rs 3,50,000

EBIT Rs 1,50,000

Interest Rs 50,000

EBT Rs 1,00,000

Tax @ 30% Rs 30,000

EAT Rs 70,000

Also given : Capital Rs 2,50,000 consists of Rs 1,50,000 equity funds having 15% cost and

debt of Rs 1,00,000 having 12% interest.

Step 1: Calculating Net operating profit after tax

Total revenue Rs 5,00,000

Less: Operating expenses Rs 3,50,000

EBIT or Operating profit Rs 1,50,000

Less: Tax @ 30% Rs 45,000

NOPAT Rs 1,05,000

( Alternatively EAT, Rs 70,000 + interest, Rs 50,000 tax savings on interest, Rs 50,000 x 0.3 =

Rs 15,000 Thus, NOPAT = Rs 1,05,000 )

Step 2: Calculating Capital charge

Equity (Rs 1,50,000 x 15%) Rs 22,500

Debt (Rs 1,00,000 x 12%(1 - 0.3) ) Rs 8,400

Total capital charge Rs 30,900

8/6/2019 108_EVAandVAS_BatchB

3/3

Step 3: Calculating EVA

Economic value Added = Rs 1,05,000 Rs 30900

= Rs 74,100

Implications in an industry

EVA approach is a modified accounting approach to determine profits earned after meeting all

financial costs of all the providers of capital. It considers independent projects, thus the analysis

of projects which are capital intensive is very essential as the cost of capital of such projects are

usually very high. So an EVA is a better indicator of the returns of the firm rather than a profit

statement.

Advantages of Economic value added

1. It explicitly considers the cost of capital for measuring the firm s performance.

2. It views projects independently, hence when a management wants to focus more on

singular projects, EVA is very helpful.

3. The most important advantage is that it provides the true measure of the economic profit

and not just profit derived from profit and loss statement.

Disadvantages of Economic value added

1. Difficult to calculate.

2. EVA is difficult to distribute among employees, shareholders etc. hence difficult to createa value added statement also.

3. EVA does not involve forecasts of future cash flows and does not measure present

value. Instead, EVA depends on the current level of earnings.

Advantages of Value added statement

1. It enables the investor to compare his companys prospects with other companies.

2. The distribution and division of wealth is useful for a company to see how much wealth is

going where and hence they can take measure to see if something can be done to

increase or decrease the value.

3. It gives the actual value added rather than just calculating the profit. Because value

added is what actually the firm has done in the business.

Disadvantages of value added statement

1. A value added statement is not very popular as mostly the P&L statement is used by

financial analysts. Still most people believe in the profits rather than the value added.

2. There is no standard format for a value added statement but there is a proper format for

a profit and loss statement.