Economic Value Added

Economic Value Added (EVA) is a technique of accounting that is aimed at providing the market, stakeholders, and shareholders with a less opaque and more trustworthy view of [Page 174]a company's prudent use of resources and overall economic health. EVA can also be called economic rent or economic profit. Although the application of EVA has been adopted by companies from all business sectors, businesses with an interest in sustainability and green enterprise have adapted it to include considerations that may have both direct and indirect environmental effects. A prominent example is the natural grocery store Whole Foods Market. Given the vast, but not uniform, adoption of EVA across the spectrum of the green sector, debates have raged concerning how value creation or destruction is defined, especially in light of the challenges posed by new paradigms such as ecoeffectiveness and extended product responsibility.

EVA was created as a proprietary system and trademarked by Stern Stewart & Co., a New York management consulting firm. EVA has been promoted as a system that helps to avoid accounting problems that in the past have allowed companies to produce statements and U.S. Securities and Exchange Commission (SEC) filings of profits while actually teetering on the edge of bankruptcy by hiding debt. Of course, the real estate bubble of the late 2000s and the use of mortgage-backed securities, as well as credit default swaps, demonstrate that assessing value gained is always difficult.

It is commonly held that, to determine the EVA for an enterprise, one must tally the weighted average cost of capital, multiplied by the total capital invested. This is then subtracted from the net operating profit after tax (NOPAT) to obtain the EVA, or the enterprise's profits adjusted for the expense of financing capital. Because the calculation of the NOPAT is essential to determining EVA, it is important to clarify what constitutes NOPAT.

NOPAT is a common calculation of generally accepted accounting principles, as well as a term common to green business. It is considered to be a company's operating profit after taxes have been deducted. Operating profit is the company's earnings in a given period before interest and taxes have been deducted. Calculating NOPAT is done by starting with earnings before interest and taxes (EBIT), converting accrual (accumulated revenues, which can include money owed to the company but not yet paid to the company) into cash, and capitalizing some expenses on the balance sheet to reflect the fact that they are investments. At that point, taxes are deducted. The difference between NOPAT and EBIT is essential to understanding the applications of EVA to multiple business settings.

Proponents of EVA argue that it is an accurate performance metric for measuring the success of senior leadership to increase value in an enterprise. For green businesses, or businesses that are including green elements in their management plans, EVA can be an additional method for showing vision and efficient use of resources. Other wealth metrics, like equity market capitalization, depend on the performance of the company's stock price and, therefore, are affected by market swings and macroeconomic trends. These methods essentially measure the success not of the company but of the stock price. Conversely, a performance metric like EVA reflects the company's actual performance and is the result of management decisions in a way that stock performance is not.

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