A key to wearing EVA into the corporate culture is to make it the focal point for reporting, planning and decision making. To do that requires two things. The first is the productivity. It can should supercede other financial and operating measures, resulting in a hierarchical as opposed to a “balanced” scorecard. If EVA is merely added to a list of many other performance measures, confusion and unnecessary complexity will remain. The second requirement is that the EVA be incorporated into the decision making process.
The three ways to increase value:
Only three basic ways to increase value:
- I) increase the returns from the assets already in the business by running the income statement more efficiently without investing new capital.
Ii) invest in additional capital and aggressively build the business so long as expected returns on new investments exceed the cost of capital.
Iii) release capital from existing operations, both by selling assets that are worth more to others and by increasing the efficiency of capital by such things as turning working capital faster and speeding up cycle times. How is EVA superior to other measures of financial and corporate performance? Traditional measures of corporate performance assume that there is no charge on equity. Dividends are out of profits and if a company does not shareholders funds are for disaster.
Shareholders expect at least a market rate of return when they buy a company’s share. Second, traditional measures of corporate performance argue that since a company’s profit after they are comprehensive measures of managers to take decisions that will boost the bottom line. The principal liabilities are likely to be cost related to R&D and in Profit after Tax. This approach will inhibit growth and eventually destroy shareholder value.
In contrast, the EVA process requires that expenses like R&D and market development be capitalized over a 5 year periods. EVA has standardized the financial accounting process independent of the balance growth of an organization and all is sacrificed at the altar of short-term results. By using EVA to evaluate options, a company will choose the strategy those results in the maximum addition of shareholder value. For instance, logistics major Ryder System basis its pricing uses EVA as part of the due-diligence process while acquiring additional companies.
All this makes EVA an ideal tool for of companies on EVA. Corporate giants like Coca Cola, AT&T and others through EVA have greatly increased the value of the companies.
A standard allegation against EVA is that the excessive focus on Return on Capital Employed (ROCE) and Cost of Capital (COC) constraints capital growth and promotes difference between the company’s NOPAT and its capital charge in one it encourages managers to postpone or ignore capital investments that do not generate immediate returns. This, they say gives impetus to the company’s ROCE in the short term.
In reality, EVA promotes the long term by putting a portion of their bonuses at risk if there is a subsequent decrease in the company’s EVA. Equally important, because bonuses are bases on earn large bonuses is by finding ways to profitably grow managers for any growth regardless of whether it provides returns vis-a-vis the cost of capital (COC). In effect, EVA encourages managers to returns in the long term.
If EVA has been in existence for 18 years, why have a mere 300 companies across the world and only a few companies like HLL, Infosys, NIIT, in the implementation accounting systems. 160 odd adjustments that have to be made to the financial statements of a company before calculating its EVA, may turn CEOs away. Domestic profits could well disappear when adjustments for accounting that the companies it helps implement EVA also implement the EVA based incentive compensation or variable compensation model.
Managers are loath to set in motion something that could affect their EVA will find that its employees acquire an unrelenting focus on could well be this wonderful tool’s greatest achievement. Some important strategies for success, using EVA, for old world companies to compete in this risky new e-world are:
- Whether old or new, rapidly make full use of the web.
- Be more patient with internet investments.
- Ignore accounting statements, treatment research, development, selling and marketing costs as investments and measure business performance with EVA.
- Experiment and accept failure as integral to the learning process.
- Think outside the box about ways the interconnected world can help you deliver your product or service more efficiently, or make your offering more valuable and differentiated from competitors.
- Invest in real options and position your company to have as many worthwhile opportunities for the future as possible.
- Recognize the value of human capital and allow the true stars to take part in the success of the organization.
- Thinking about survival and take an offensive position.