The EVA Challenge - PCC - ebook

The co-founder of EVA shows how to apply it in today's neweconomy EVA-economic valued added-is a measure of the true financialperformance of a company, and a strategy for creating corporate andshareholder wealth. It is also a method of changing corporatepriorities and behavior throughout a company, right down to the"shop floor." In The EVA Challenge, the authors outline how toimplement EVA-from training employees to answering the mostfrequently encountered implementation problems faced bycompanies. This detailed "how-to" guide represents the second phase in the"EVA Revolution", showing executives around the world how tocustomize and implement EVA at their companies. Here, EVA convertslearn how to work some "EVA magic" through company-specificinitiatives and case study examples. Coverage includes completelynew materials on "real options", leveraged stock options, and otherconcepts critical to corporations in both new and old economyindustry sectors.

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Economic Value Added (EVA) is the best and most direct measure of whether a business is creating wealth when the cost of its capital has been taken into account. EVA also aligns precisely the interests of the company's owners (its shareholders) with the interests of the managers in a way that is free of the distortions and vagaries of accounting conventions.

The challenge is to harness EVA effectively to increase true economic profitability. That will require three components a measurement system, an incentive system and a financial management system which are all EVA based. Without those components, it will be impossible to tell whether or not a business is succeeding in making its capital worth more over time. With those elements properly implemented, EVA principles will unerringly guide the company onwards and upwards as managers and employees focus on one specific objective: "How do we improve our EVA?"

In the final analysis, EVA is the best and most definitive financial performance measure. Smart companies worldwide are harnessing EVA to optimize their creation of shareholder wealth over time by making it the focal point for all reporting, planning and decision making functions.

Section 1The Problem with Conventional Valuations

How do you value a business? The conventional measures are to use:

Profitability--the existence of excess cash flows.

Earnings per share (EPS).

The price/earnings ratio (P/E).

Return on equity (ROE), investment (ROI), net assets (RONA).

The only problem is all of these measures can be distorted in the short term by management accounting practices which are perfectly within the law. The situation becomes even murkier in one-off situations like acquisitions and leveraged buy-outs.

Thus, a consistent, unambiguous and rational way to value a business is required in order to gauge whether or not the management is actually creating more value over time.

muddied the waters when it comes to valuing a business are:

1. The split between ownership and control.

For most public companies, ownership of the shares in the company are spread over thousands of shareholders while management control is vested in the hands of professional managers. That's a problem because the manager's best interests don't necessarily align with those of shareholders and managers always possess detailed inside information the other shareholders lack. In addition, shareholders want to maximize dividend payments and stock price appreciation while managers want to maximize their opportunities to earn bonuses.

2. The attempt to use accounting measures for valuation.

Accounting measures have historically evolved to determine residual value in the event a company is wound up. Thus, they are ill equipped to assess the current economic value of a company as a going concern. Which, in turn, means generally accepted accounting practices by law distort the true market value of a company.

In addition, accounting measures can be easily distorted by the management in order to make one quarter's figures better or worse. Take, for example, the widely used earnings per share (EPS) measure. This can be distorted by:

■ Cutting back on research and development expenditure for a quarter, thereby lowering costs and raising stated profits at the expense of failing to develop the new products which will be needed in the future.

■ "Trade loading. " This is the practice of force-feeding compliant customers with more merchandise than they need just before the end of an accounting cut-off date. The customer may even be offered extended credit on their purchases.