What is the concept of economic value added (EVA)?

The concept of economic value added (EVA) focuses on assessing a company's financial performance by looking at the residual wealth created after accounting for the cost of capital. In essence, EVA measures how much value a company generates for its shareholders over and above the cost of financing its operations.

It is calculated by taking the operating profit of a company, typically referred to as net operating profit after taxes (NOPAT), and subtracting the capital charge, which is the product of the company’s total capital and its weighted average cost of capital (WACC). If the resulting number is positive, it indicates that the company is generating value over and above its capital costs, thus demonstrating effective use of its assets.

This definition captures the notion that true profitability is not merely about generating revenues but also about ensuring that those revenues exceed the costs associated with generating them, including the cost of equity and debt. This concept aligns tightly with shareholder value maximization, making it a critical metric in financial analysis.