Economic Value Added: A Detailed Walkthrough

Essay from the year 2013 in the subject Business economics - Investment and Finance, grade: 2,0, International University of Applied Sciences Bad Honnef - Bonn, course: Current Issues in Accounting & Finance, language: English, abstract: In the past, key financial instruments were focusing on concepts like the return on investment, return on equity and return on capital employed. However, within recent years, the flaws of the named ratios made it difficult to thoroughly rely on such figures any longer. As one key drawback connected to those solely finance-related ratios was that all non-financial aspects are missed out on. Further, the economic value creation was not respected in past models. EVA®, economic value added, is a concept on the rise that counteracts the flaws of recent financial ratios. By accounting for both the capital charges for investors and creditors, it allows a more sophisticated look into the value creation of a company. However Stern Steward & Co, who founded EVA®, give recommendations, so called adjustments, in order to make EVA® even more effective as it is without. As economic decision are not only covered by introducing a new ratio, it is important to contrast and to integrated EVA® to other frequently used financial models. Here, the net present value calculation is used most when evaluating on whether or not to take on a project. Now, the author shows that EVA® even can be used for net present value calculations, which is usually done by taking into consideration future cash flows. Further, economic profit is not all a modern business has to care about. In this respect, cash management has evolved in becoming a crucial cornerstone in financial management. Hence, the author has compared the cash conversion cycle to the EVA®. The questions is, does liquidity also affect the EVA® result? Finally, the author concludes on whether or not EVA® can be regarded as 'the one financial ratio' an how it interplays with other important models used in modern companies.