Like the wicked queen in the tale of Snow White, analysts are forever trying to identify the fairest of them all — the strongest, most innovative, and fastest-growing companies. Finance executives, in turn, are constantly seeking a metric that communicates a company’s financial condition in a way that enables employees to make rational decisions about operations. There is no shortage of metrics, but as the past two years have witnessed, many of them, in particular EBITDA and pro forma, have been vulnerable to distortion.
Enter MVA, or market value added, which measures the amount of wealth a company has created since its inception. MVA is an extension of EVA (economic value added), a metric that became popular in the 1990s, when companies used it to measure profitability not just at the corporate level, but also at the level of business units and individual projects.
EVA is described by Bennett Stewart, senior partner at consulting firm Stern Stewart & Co., which has trademarked the acronym, as an estimate of the amount by which earnings exceed or fall short of the rate of return shareholders and lenders could get by investing in other securities of comparable risk. “EVA is a practical method of estimating the economic profit that is earned, as opposed to the accounting profit,” he says. “It’s really a finance tool for nonfinance executives. Finance execs don’t need EVA.”
“It simplifies everything,” insists Sal Fazzolari, senior vice president, CFO, and treasurer of Harsco Corp., a Camp Hill, Pennsylvania-based industrial-services firm, which began implementing MVA and EVA as financial-measurement tools in 2001. “It’s one measurement for everyone in the company to concentrate on. It takes into consideration all of a company’s financials.”
At the heart of MVA and EVA are the beliefs that (1) the primary objective of management should be to maximize return to shareholders and (2) a company should earn more than its cost of investment.
In a nutshell, EVA is equal to a company’s net operating profits after taxes (NOPAT) minus a capital charge — the amount of capital invested in the business times the cost of capital. EVA converts the balance sheet and income statement into one measurement of profit, Stewart explains.
“It’s as if the company ended up with no assets and leased everything, factored all receivables,” and so on, he says, adding, “it’s the profit that would be reported if all assets were externally financed.” Stewart argues that looking at financials in this way enables a company to truly understand whether it is profitable because it manages assets well or simply because it is an owner of assets.
Fazzolari says that for many years, different business units at Harsco focused on a variety of metrics, such as return on capital, return on sales, net income, and sales. “These metrics can send you in different directions,” he says. “EVA makes you focus on all of the financial statements.”
EVA has enabled Harsco to improve its capital-allocation process by standardizing the way each manager and employee analyzes a project. For example, if a customer requests an extra 30 days to pay its bill, Harsco’s employees can immediately calculate the potential financial impact on the company. Each month, Harsco calculates EVA by business unit. “It is automatically generated,” says Fazzolari. Each employee can then access the tools needed to calculate EVA.