How To Improve Economic Valued Added(EVA) KPI?

To answer the question of how to improve EVA,let’s re-look at its formula:
EVA=Net Operating profits after tax – (Capital Employed x Cost of capital)

Generally,we can improve EVA by reviewing the components or drivers of EVA:

NOPAT IMPROVEMENT:

• NOPAT is involves with revenue and profit growth. So to improve EVA we need to try to improve the returns with no or with only minimal capital investments.
  We should try to improve the business gross margin and looks at areas for effective cost spending or reduce costs where wastage might exist.

• Also don’t forget that the effective tax rate (ETR%) is also very important as the higher the overall ETR compare to the normal corporate tax rate ,the more cash flow would have being drained off from the business.

Perhaps,you might look at areas like the various tax incentives offer like re-location,export incentives,industrial building allowances,free trade zone to reduce the overall business effective tax rate.

CAPITAL EFFICIENCY IMPROVEMENT:

• Capital employed is essentially the total assets minus any non-interest bearing liabilites

If you observe that the computation of EVA,the higher the capital employed,the higher will be the capital charge which relates to the inefficiency of the capital employed. Hence,we need to re-look into areas pertaining to the returns versus quantum of capital investments and the utilization or turnover of the assets (capital).
Like the way to improve return on assets ratio,we should turn to improving higher assets turnover whether in terms of stocks,debtors and also by making fixed assets more productive will enhance EVA. This is again assuming that there is no or with only minimal capital investments.

To improve capital efficiency hence improving EVA,we should attempt to:

• Invest new capital only in projects,equipment,machines able to cover capital cost while avoiding investments with low returns
• Identify where capital employment can be reduced
• Identify where the returns are below the capital cost;
• Divest those investments when improvements in returns are not feasible

COST OF CAPITAL

The next driver in EVA is the Cost of Capital. Cost of capital is a barometer to measure the financing efficiency. Normally,most companies would have certain level of gearing. Hence,by optimizing gearing with the right instruments,rates and quantum should to a certain extent lower the weighted average of cost of capital.

• Advantages and Disadvantages of Using Economic Value-Added (EVA) As Performance Indicator or KPI
• What Is Economic Value-Added (EVA) And The Comparision To Earnings Per Share Or Return On Assets
• FRS 112-Reconciliation Of Effective Tax Rate To Statutory Rate
• What is Cash Operating Cycle And Ways To Improve Cash Flows
• Return On Capital Employed Versus Residual Income As Divisional Performance Evaluation Tools
• Market Value Added (MVA)
• Issues Or Challenges In Managing Working Capital