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EVA AN OVERVIEW AND A CASE STUDY

EVA is simply net operating profts ater tax, minus a charge or the useo capital employed in the business. The capital charge is the minimum

rate o return necessary to compensate shareholders, and lenders orthe risk o their investments in a company. Research shos thatchanges in EVA has a closer correlation to changes in shareholdervalue, hen compared to other metrics like Earnings !er "hare #E!"$,Earnings %roth, Return on E&uity #R'E$, and Return on Assets #R'A$.

To improve EVA ( )nvest in pro*ects that earn more than the cost ocapital ill help in achieving groth to improve EVA

)ncrease profts ithout using additional capital ill help in increasingEVA through productivity improvement.

+ivest non(strategic assets that do not generate operating proftsgreater than the cost o capital.

EVA vis--vis other Metrics

"ales, -V, "V'!, groth rates

( EVA orces Top(line groth to generate sustainable profts in thelong run and to also keep an eye on apital Employed

ost Ratios, %ross ontribution, '"

( EVA compares Returns generated ith the cost o apitalEmployed to generate these returns

et +ivisional Assets, Asset Turns, R')

Average et /orking apital, Turns

( EVA ensures 'ptimum and !roftable 0tili1ation o all -usinessAssets

et 2unds 2lo to orporate Treasury

( EVA also includes non(cash costs like +epreciation( 3easuring and Reporting EVA at %4-

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Basis of EVA:

( 'b*ective o maximi1ing "hareholder Value( Value depends on Residual )ncome #EVA$, hich includes income

5let over6 ater providing or ade&uate returns to 7enders#)nterest$ as ell as "hareholders #+ividend$

( EVA looks at 5true6 or 5economic6 earnings instead o Accountingearnings

( 2ocus on !rofts A+ apital E8ciency

EVA as a erfor!a"ce Metric

( omprehensive9 it integrates the !47 Account #'"-)$ ith the-alance "heet #E$

( Aligns "hareholders: interests ith those o Executives; EVAincreases only i shareholder /ealth increases

( A single number is reported( Accesses fnancial data easily available rom the existing 3)"( )solates extraordinary < non(recurring items( an be seamlessly integrated ith decision making logic, e.g.;

positive !V pro*ects < apex increase EVA, 'ptimal ost and!rice decisions based on marginal costing also optimi1e EVA

The Co"ce#t O$ EVA

( 2unds employed in -usiness can be supplied by "hareholders orby 7enders #-anks and 2inancial )nstitutions$

2

LIABILITIES

Sources of Funds

ASSETS

Application of Funds

Share Capital

Reserves/Surplus

(Past Profits)

Share

holders!

Funds

Lon" Ter# LoansShort Ter# Loans

($or%in" Capital)

Borro&ed

Funds

Fi'ed Assets

Invest#ents

et $or%in"

Capital

(Current Assets Current

Liailities)

Assets

E#plo*ed

in

Business

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( 2unds so obtained are invested in 2ixed Assets, )nvestments and/orking apital

'"-)

( Tax is ignored, since %4- has ade&uate tax shelter that can beset o= against uture business profts. Taxes are not relevant toan "-0 in %4-:s portolio o businesses

apital Employed

( +ivisional Assets include +ivisional 2ixed Assets, et /orkingapital #"tocks > +ebtors ? reditors ? Advances$ andapportioned ommon 'perating Assets

/A

( ost o +ebt is calculated on a monthly basis depending onactual levels o +ebt

( ost o E&uity is the level o returns expected by shareholders

Ca%c&%atio" of EVA

EVA @ '"-) minus A!)TA7 AR%E

A N&!erica% E'a!#%e

3

Fi'ed AssetsFi'ed AssetsInvest#ent

s

Invest#ent

s et $or%in" Capitalet $or%in" Capital

Shareholders! FundsShareholders! Funds Borro&ed FundsBorro&ed Funds

et +peratin" Surplus efore Interestet +peratin" Surplus efore Interest

Funds Employed Cost of Funds Employed

Capital Char"eCapital Char"e

E,AE,A

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( '"-) @ '" BCD > )nterest D @ FDD( E @ 2ixed Assets FGD > et /orking apital FDD @ HGD( /A is a combination o /A o +ebt and /A o E&uity( /A o +ebt @ #GDICJ>CGIBFJ>BFGIBHJ$ < #GD>CG>BFG$ @ D

< FGD @ BFJ( /e A""03E /A o E&uity @ FDJ #hoK$

( /A @ #FDDIFDJ>FGDIBFJ$ < #FDD>FGD$ @ BG.GGJ( apital harge @ E HGD I /A BG.GGJ @ CD( EVA @ '"-) FDD ? apital harge CD @ BD

EVA at (o)re* + Bo,ce

( Annual change in EVA, i.e. EVA is measured( 3apping EVA and EVA to perormance;

What EVA Is "ot + IS

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/hat EVA is not( A totally ne, exotic !erormance 3etric( A complete substitute or all existing !erormance 3etrics( The anser to all -usiness problems, strategic as ell as tactical

/hat EVA is

( A more comprehensive 3etric that encompasses the broadunctionalities o many, but not all, other 3etrics

( A means to align orporate action ith "hareholders: interestsand sustained /ealth reation

( 'ne o the management tools available or !lanning andVariance Analysis

I"terati" EVA i"to B&si"ess %a""i"

"trategic apital Expenditure < !ro*ect Analysis( Traditional !V or )RR evaluations ill yield results consistent

ith EVA9 !ositive !V results or )RR values higher than /Aill yield positive EVA

( 2or ma*or apex #%reenfeld pro*ects$, certain expenses likedepreciation and set(up costs might have to be amorti1ed over alonger period or EVA purposes

'perational +ecisions( #!ricing, )n(house v. "ub(contracting, Volume +iscounts, ash

+iscounts, 3anuacture v. Trade$( 3arginal ost < 3arginal Revenue based decisions ill yield

results consistent ith EVA9 osts < -enefts o 3arginal apitalEmployed need to be considered as ell ? e.g. increase in+ebtors or )nventories

-usiness planning ocuses on, and reards( EVA. 3anaging or Value reation means rebuilding %4- as an

organi1ation o 7ong term "hareholder Value managers( +oes Return on apital Employed exceed /AK 2irms create

"hareholder Value only i they make decisions that consistentlyearn Economic !roft, i.e., a Return on apital Employed thatexceeds the ost o fnancing that )nvestment.

( "trategic 2ocus or 7ong Term "urvival and !roftable, "ustainable%roth. Revie o "trategic Value +rivers.

7ong term "hareholder Value managers

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( 3anaging or Value reation means rebuilding %4- as anorgani1ation o 7ong term "hareholder Value managers

onsistently earn Economic !roft+oes Return on apital Employed exceed /AK

( 2irms create "hareholder Value only i they make decisions thatconsistently earn Economic !roft, i.e., a Return on apitalEmployed that exceeds the ost o fnancing that )nvestment

"trategic 2ocus or 7ong Term "urvival and !roftable, "ustainable%roth( Revie o "trategic Value +rivers( !roftable groth in -usinesses that are Luality < ost

competitive( apex controls < /orking apital controls( %eneration o 2ree ash 2los

( !rudent +ebt or Asset -uild(up in !roftable "unrise )ndustriesor sustained %roth ith Economic !roft

( onstant "trategic Revie < Exit "trategies

!roftable groth( !roftable sustained groth in -usinesses that are Luality < ost

competitive( apex controls < /orking apital controls( %eneration o 2ree ash 2los( !rudent +ebt or Asset -uild(up in !roftable "unrise )ndustries

or sustained %roth ith Economic !roft

( onstant "trategic Revie < Exit "trategies.

I"terati" EVA i"to B&si"ess

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Wa,s to raise EVA

Earn more !roft ithout using more apital

( e.g., ost utting in !rice(competitive markets

0se 7ess apital( 'ptimi1es the use o apital, both E&uity and +ebt( 3akes !ro*ects and !roducts compete or apital( urtails apital in -usinesses that do not cover /A( apital released can be used to repay +ebt, esp. at a highly

geared company like %4-( )nvest apital in high(return !ro*ects( !roftable and "ustainable %roth

)nvest apital in high(return !ro*ects

EVA a") Ma"aeria% Re.ar)s

3anagerial %oal(orientation, 3otivation and Reard "tructure( EVA and EVA( 2ocus on tin M!):s o !rofts as ell as apital Employed( A Mey Variable or !erormance(based Reards to senior

3anagers

The "tructure o EVA(based 3anagerial Reards( Rearding EVA motivates proft(making +ivisions even in

stagnating markets( Rearding N EVA motivates loss(making +ivisions to seek

constant improvements in perormance( Rearding N EVA more than EVA orces all +ivisions, including

those making profts, to earn more profts and

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Addition in thi" profit i" /"1++ Then it i" decided to di"trib#te thi" a$o#nt) do(n theorgani0ational chain

*f EVA & N EVA i" 1++ /" then in the organi0ation the di"trib#tion done i" a" follo("

/" 5+

V-#pport #nction" /" 25

V7ine #nction 8i%i"ion9 /" 25

-i$ilarl!) for e%er! -. -trategic #"ine"" .nit the di"trib#tion follo("

:f the /" 25) di"trib#tion i" a$ong"t the re$aining chain ele$ent of the orgain"ation

Vice re"ident /" 1

General anager /" 15-enior anager /" 25

anager /" 35

ep#t!anager /" 45Exec#ti%e /" 55

:perator" /" ,

Tho#gh the a$o#nt to the :perator" appear" high the n#$ber" of di%i"ion" are higher) ieif ,++ operator" are there) then /" , i" di%ided into ,++ "hare") ie /e ++1 per operator

-i$ilarl! if there are 2,5 Exec#ti%e" each get" /" ++2

The objecti%e i" to di"trib#te the profit" and re(ard e%er! ele$ent of the chain or

organi0ational p!ra$id

Godrej

re"ident

-taff

#nction

re"ident

7ine

#nction

Aero

-pace

-. V

#rnit#re

-. V

-oap"

-. V

V

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COMPILED BY CHHAYA SEHGAL

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