Economic Value Added (EVA) is a method to calculate the economic profit of a company. EVA can be calculated as Net Operating Profit after taxes less a charge for the opportunity cost of the capital invested. The underlying principal of this method is to determine whether company is earning higher rate of return on the funds invested than the cost of the funds. If it is earning higher rate of return then it implies that management is adding more wealth to the shareholders value.
Advantages of EVA
1. It helps the company in monitoring the problem areas and hence taking corrective action to resolve those problems.
2. It can also improve the corporate governance of the company because since a higher EVA implies higher bonuses to the managers they will be working hard and also honestly which in turn augurs well for the company.
3. Unlike accounting profit, such as EBIT, Net Income and EPS, EVA is Economic and is based on the idea that a business must cover both the operating costs as well as the capital costs and hence it presents a better and true picture of the company to the owners, creditors, employees, shareholders and all other interested parties.
4. It also helps the owners of the company to identify the best person to run the company effectively and efficiently.
5. Using EVA company can evaluate the projects independently and hence decide on whether to execute the project or not
However there are some disadvantages of EVA like it is difficult to compute and also it does not take into account inflation into its calculation. Therefore company should take into account above advantages and disadvantages before deciding whether to implement EVA or not