What is the concept of economic value added (EVA)?

Economic Value Added (EVA) is fundamentally a performance measure that calculates the residual wealth generated by a company after deducting the cost of capital from its operating profit. This concept emphasizes the importance of not only generating profits but ensuring those profits exceed the costs associated with the capital used to achieve them.

When a company generates returns greater than its cost of capital, it is effectively creating value for its shareholders. This metric is significant because it aligns a company's financial performance with the interests of its investors, making it a useful tool for evaluating how well a company is performing relative to the capital invested in it.

This approach provides a clearer picture of profitability by considering the true economic cost of all the capital invested in the business, which often goes unaccounted for in traditional profit measures. By focusing on the concept of "residual wealth," EVA helps companies identify how effectively they are utilizing their assets to generate meaningful returns, thereby enabling better decision-making aimed at enhancing overall financial performance.