Analysis of EVA as a financial performance measure
The last two decades have experienced significant changes in the way companies implement their goals and measure the effectiveness of the strategy. Top managers are under pressure of capital markets to generate greater than ever profits for the firm by undertaking right evaluation metrics. So, different significant factors like advancements in capital markets, information technology and, generally, globalization has led to appearance of the new notion in companies. (Yong, p.5) Creation of wealth for shareholders has become the key concept for the firm to be efficient and competitive in the market. In this case, this essay will focus on ...view middle of the document...
Now, it becomes clear the top management needs to practice different approaches to implement their strategies if they want to succeed and generate value for the business. As the financial metrics needs to evaluate the strategic objectives of the firm, the right strategy needs to be firstly identified. Porter argues in most of his works that there is often a wrong interpretation of what the strategy of the firms should be, in the context of modern market. In his works he shows that the strategy is shaped by five competitive forces, which constitute not just of the narrow component of rivals, but also includes new entrants, suppliers, buyers and substitutes. To have a nice strategy, in this case, Porter claims, the company should identify the industry structure in which it works, so that strategic importance of industry attributes can be investigated through the lens of the five forces. This is essential to have a good forecast of the future of the firm, to recognize the potential strengths and weaknesses of the projects. According to Kaplan it is crucial to have the right tactics to evaluate the implementation of the strategy.
In this way, the Balanced scorecard performance measurement framework was introduced by Kaplan and Norton, which helps to identify the clear objectives of the business after the overall strategy is clearly understood. It captures a number of financial and non-financial measures, and each can be categorized into four perspectives such as customers, internal process, learning and innovations and financial performance, with two to five measures under each category (Kaplan, 1996). Clearly, EVA is one of the financial metrics which can be used to evaluate financial aspect of the strategy, so that it can be balanced by Balanced Scorecard method with other non-financial aspects. Consequently, the strategy is the most essential to be identified unmistakably, as all the businesses use varying performance measure depending on the strategy they have chosen.
Economic Value Added is one of the financial metrics, which is used to monitor the results of the companies’ strategy, in terms of the profits it created. This value is based on three elements and can be calculated by subtracting the product of the investments in assets and weighted average cost of capital from the net operating profit after taxes. It states that the return on any given investment of capital must be larger than the incurred cost of this capital.
Being introduced and later trademarked by Stern Stewart, this technique has gained much of the significance and discussion in press during the latest decades as innovative and non-traditional one. But what is that is so special about it that attracts so much attention?
Obviously, this idea is not new, as its underlying concept is same as that of the residual income. The feature which distinguishes EVA from RI is that it does not conform to the conventional accounting standards introduced by GAAP (generally accepted...
