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What defines success in business? Many organizations struggle to find that perfect metric – the one that will definitively answer that question once and for all. And no wonder! There is a seemingly endless supply of performance metrics available to choose from. Revenue, Gross Margin, Cash Flow, EBIDTA and many more: each of these tells a story about the health of a business. But does any one of them tell the whole story? The answer is no. And, when combined, they often provide competing perspectives that must be reconciled by the Executive Leadership Team before they can report back to their shareholders.
Does that single, one-size-fits-all metric exist? We at Venetia Partners say yes. We believe that measuring business performance doesn’t have to be complicated. What’s needed is a proxy to show whether the decisions the business makes are generating net profit. Once you’ve got that answer, your organization can report on performance from a universal perspective. Economic Value Add (EVA) is the proxy that will always show how much profit will be generated, regardless of the process you’re evaluating.
Not only is it a one-size-fits-all tool, EVA is also a simple measure to grasp. It’s a three-line profit calculation: Sales, less all Operating Costs, less a full Cost-of-Capital interest charge applied to the Net Assets invested in the business.
EVA = (Sales-Operating Costs) - (Net Assets*Cost of Capital)
Check out the accompanying Economic Value Add (EVA) Infographic to see just how simple it can be to calculate EVA. For a company with $100K in sales, $85K in operating costs, $100K in net assets and a weighted average cost of capital of 10%, the EVA is quickly determined to be $5K. One formula that shows the profit that remains after deducting all costs, even that of providing lenders and shareholders a minimum competitive return on their investments.
When increased, EVA creates economic value; when decreased, EVA destroys that same value. This simple, yet powerful, metric is the only one that can calculate value across industries, regardless of organizational complexity. Not only appropriate for corporations, EVA is also applicable to Private Equity and individual investors as well to enable smart buy-sell decisions and improve portfolio returns.
Bottom line? EVA should be the number one metric to aid in any organization’s decision-making. It is the only calculation you need to make complex decisions simple.