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¶ … Economic Value Added Statements Improve Financial Reporting
There are many potential advantages of using Economic Value Add analysis to improve financial reporting, results and increase the probability of success for specify investment initiatives and programs. There are also limitations or problems with this technique as well, which are briefly described in this analysis.
Analysis of Earned Value Added (EVA)
In defining EVA, the equation used for calculating it is based on the Return on Assets (ROA) subtracted from the weighted average cost of capital multiple by total capital (Burkette, Hedley, 1997). The equation is often shown as ROA -- Weighted Average Cost of Capital x Total Capital. The benefits of this approach most often cited by companies using it and researchers who study its adoption is the ability to create a single, unified objective measure of corporate performance that cannot be manipulated or inflated easily (Burkette, Hedley, 1997). Second, the EVA measurements in many corporations are used for evaluating different investment alternatives and also prioritizing them for specific investment criterion and objectives (Pajoohi, 2012). Third, EVA is excellent at measuring the opportunity costs of different business investment and operations over time (Colauto, Ulisses, Wagner,...
EVA has proven to be effective in measuring how much capital is created or destroyed directly as a result of investment decisions made over time (Burkette, Hedley, 1997). Due to all of these factors, EVA is also extensively used for quantifying the relative levels of risk in a given investment alternative relative to another. His aspect of EVA is also extensively used in the context of Governance, Risk and Compliance (GRC) initiatives throughout organizations as well. Corporations who are in risk-intensive industries are relying on EVA as a metric to evaluate the relative GRC position of specific items in their portfolio as well (Colauto, Ulisses, Wagner, 2009). EVA is often seen as a stand-alone measure of potential opportunity cost relative to risk and the long-term value of a given investment. Yet it is increasingly being used for portfolio management to rank order and evaluate entire ranges of potential investment decisions as well (Pajoohi, 2012).
The problems or downsides of the EVA approach to measuring economic value include how poorly this approach interprets and defines accurate period-based returns for a single investment (Colauto, Ulisses, Wagner, 2009). This approach also will underestimate the beginning of a given investment and underestimate the payouts as well. Using the EVA approach to…
References
Burkette, G.D., & Hedley, T.P. (1997). The truth about economic value added. The CPA Journal, 67(7), 46-50.
Colauto, R.D., Ulisses, O.C., & Wagner, M.L. (2009). Economic value added and net income: Evidences new market. Revista De Contabilidade & Controladoria, 1(3), 185-n/a.
Pajoohi, N. (2012). Economic value added from theory to action. Arabian Journal of Business and Management Review (Oman Chapter), 1(11), 1-4.
However, EVA is neither as perfect as claimed by its advocates, nor is it the only performance measure that suggests a path to a superior stock return" (emphasis added) (p. 319). More importantly, though, while the economic value added measurement approach to financial performance may not be without its detractors, the scholarly literature is consistent in emphasizing the need for such initiatives for companies to remain competitive in an increasingly
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