By Al Ehrbar

Sign up for the FP&A Newsletter for more articles.

A recent innovation in economic value-added, or EVA, made the performance-measurement much easier to understand and greatly enhanced its effectiveness as a tool for value-based management.

The innovation, called EVA Momentum, is a simple concept. It is defined as the change in EVA over a period such as a year or a quarter divided by prior period sales.

EVA, of course, is a measure of economic profit. It is net operating profits after tax (NOPAT) minus a charge for the opportunity cost of all capital, equity as well as debt. EVA Momentum is a metric that any finance team can calculate on its own. Simply divide the change in EVA from one period to the next by sales in the first period.

This simple computation is important because it transforms EVA from a dollar measure of economic profit into a ratio.

Managers typically are more comfortable working with ratios and instinctively prefer them for comparing and analyzing performance, marking trends, judging value and setting targets.

EVA Momentum, however, is a ratio unlike all others:

• It is the only performance ratio for which a higher value always is better than a lower one. The same cannot be said of any other ratio, including earnings per share, profit margin, rate of return, or even cash flow generation. All of them can appear to improve when true performance—and value—actually have declined. But EVA Momentum grows larger only with a larger increase in economic profit.

Read full article