Why base on EVA and don't count on GAAP in your investment plan?

     EVA (economic value added) is an assessment tool to measure a firm's financial performance and to motivate its management as well. The key reasons why firm may use EVA in addition to the standard accounting measure (e.g., GAAP) are due to the disagreement between an investment's net operating income or profits after taxes and the cost of funding (e.g., EVA = Net operating profit after taxes – Capital x cost of capital) ( EVA, 2009). EVA shows true profits and gets a more true assess than just profits, and increased correlation with stock price than only gets earnings per share (EPS). EVA takes the total cost of capital ( equity and debt capital both), and not cost of debt or interest expense. EVA considers R & D as a capitalized expense on future development and not as a term expense only. Therefore as EVA value increases that also means stock value may follow—all these would help and improve overall performance. Companies uses EVA put more on allocating assets and not accounting profits only—it would intensify the development of new goods even it decreases present earnings (Gitman, 2009). In all, EVA tries to capit the real economic profit of an organization.

     Erik Stern, president of Stern Stewart & Co., that develops EAV, and claims the most challenge to take and apply EAV is to change organizational compensation structures. EVA “seeks to measure the extent to which companies create value above the cost of capital. But most compensation structures are driven by budget considerations, or worse, by negotiation and politics, and do not hold employees accountable for the capital they are entrusted with.” (Cua, 2006, p.1). The aim of EVA is to create a standard of value creation for all stakeholders and investors. Staffs must care for capital cost or expense as if they are their own money. A upward of EVA shows the management is creating value or a downward means the firm is losing its purpose or direction—a basic standard of business operation for many many hundreds of years, East or West. Employees must think and act just like owners—for those want to open a new venture, or self-employed, EVA is the first and basic tool.

References

Economic valued added (EVA). (2009). Dictionary of accounting terms. Retrieved

     March 8, 2009, from http://www.answers.com/topic/economic-value-added

Cua, G. (2006, August 28).  When pay structures become hurdles; they get in the way of

     firms adopting wealth-added mindset: Stern. The business times Singapore.

     Retrieved March 8, 2009, from LexisNexis Academic database