How Do Economic Value Added and Accounting Profit Differ?
Economic value added (EVA) is a measure of a company’s economic profit, which is the profit earned by a company minus the cost of financing the company’s capital. Accounting profit is also known as net income and is a company’s revenue minus all of its explicit costs.
How EVA Is Calculated
EVA is an internal management performance measure used to calculate true shareholder value. Unlike net income, EVA is used to measure the amount of a company’s returns in excess of its cost of capital.
Balance sheet numbers are also used in the calculation, which forces managers to think about assets and liabilities as well as revenue and expenses when making decisions on behalf of shareholders.
Economic Value Added = net operating profit after tax – (invested capital x weighted average cost of capital)
How Accounting Profit Is Calculated
Accounting profit is the traditional performance measurement of a company. It measures the net profit or loss of a company’s operations. Explicit costs are operating expenses easily identified on the income statement. Explicit costs include all cost of goods sold, all operating costs and all taxes.
Accounting Profit = total revenue – explicit cost
Accounting profit, although normally a company’s net profit or loss under U.S. generally accepted accounting principles (GAAP), is sometimes shown as net profit before taxes.
How EVA and Accounting Profit Are Different
Accounting profit is calculated using only numbers from the income statement, while EVA uses numbers from both the income statement and balance sheet.
EVA is best used to measure the performance of capital intensive companies, such as manufacturers, while accounting profit is best used to measure the performance of companies with intangible assets, such as technology companies.
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