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Eva for performance


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EVA (Economic Value Addition) as performance measure in new economy

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Eva for performance

  1. 1. Using EVA ® For Performance Measurement And Financial Management In The New Economy By Sandip De
  2. 2. New Economy <ul><li>New Economy is really integrating new technology into the business models, and that can use the web to connect more effectively with customers, suppliers and partners. </li></ul><ul><li>“ There’s no new economy. It’s the same old economy with new technology” Jack Welch, Former CEO, GE </li></ul><ul><li>Everything needs to be rethought to compete effectively – strategy, finance, human resources and organization. </li></ul><ul><li>Through this paper I have tried to explore some of the implications of the new economy for performance measure, financial management, valuation and incentive compensation etc. </li></ul>
  3. 3. EVA® <ul><li>Definition: </li></ul><ul><li>EVA is a financial measurement tool that determines if a business is earning more than its true cost of capital. </li></ul><ul><li>EVA is the net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise or project, or net income minus dollar cost of equity capital. </li></ul><ul><li>Implication: </li></ul><ul><li>Most accurate in measuring true profitability; </li></ul><ul><li>Motivates managers to think like owners and provides a common language within the corporate culture. </li></ul><ul><li>Shareholder Wealth = MVA = PV of future EVAs </li></ul>
  4. 4. EVA® <ul><li>Is: </li></ul><ul><li>An estimate of true economic profit. </li></ul><ul><li>A tool that focuses on maximizing shareholder wealth. </li></ul><ul><li>A fundamental measure of Return on Capital. </li></ul><ul><li>Calculation: </li></ul><ul><li>Estimate based on revised reported earnings: </li></ul><ul><li>EVA = [(Sales – Operating Expenses) – Interest Expenses (including Taxes) – Tax ]– [Financing Expenses x Total Capital] </li></ul><ul><ul><ul><li>= [EBIT – EBIT x Tax] – [Cost of Capital x Total Capital] </li></ul></ul></ul><ul><li>= Net Operating Income (or, PAT) - K eq x Total Equity Capital </li></ul><ul><li>= Net Operating Income - $ Cost of Equity Capital </li></ul>
  5. 5. Accounting Earnings in New Economy <ul><li>Cost of Capital </li></ul><ul><li>Retained Earnings </li></ul><ul><li>Inventory and Debtors Turnover </li></ul><ul><li>Intangibles (Cost of networking, cost of information, cost of employee skill-set, etc.) </li></ul>
  6. 6. Cases: <ul><li>Dell in regard to speedy turns </li></ul><ul><li>Kimberly-Clark in terms of information & supply chain management </li></ul>
  7. 7. Case: <ul><li>Dell in regard to speedy turns </li></ul><ul><li>Kimberly-Clark in terms of information & supply chain management </li></ul>
  8. 8. Dell Speedy Turns <ul><li>EVA ↑ when NOPAT ↑ and Cost Of Capital ↓; </li></ul><ul><li>Receivables Turn ↑ then ACP ↓, which means Cost Of Working Capital Charge ↓; </li></ul><ul><li>Inventory Turn ↑ Cost Of Holding Inventory ↓, means COGS ↓ and Margin ↑; </li></ul><ul><li>So </li></ul><ul><ul><li>Receivables Turn ↑ ↔ Cost Of Capital ↓; </li></ul></ul><ul><ul><li>Inventory Turn ↑ ↔ NOPAT ↑; </li></ul></ul><ul><li>Now , Slightly reducing the Profit Margin, Dell can increase its customer base, and make market share better. The Competitive advantage and market share gained is not reflected in conventional form of Accounting </li></ul>
  9. 9. Case: <ul><li>Dell in regard to speedy turns </li></ul><ul><li>Kimberly-Clark in terms of information & supply chain management </li></ul>
  10. 10. Kimberly-Clark IM & SCM <ul><li>K-C manufacturer -> Supply -> Costco Warehouse; </li></ul><ul><li>K-C manufacturer ← Stock Information ← Costco Warehouse; </li></ul><ul><li>K-C responsibility and action: </li></ul><ul><ul><li>Restocking Selves at 300 Costco locations; </li></ul></ul><ul><ul><li>Invest on SCM and its productivity (Inventory Carrying cost reduces and warehouse operating cost reduces); </li></ul></ul><ul><li>Result, K-C Inventory turn and receivables turn increases in a rate twice that of archrival P&G. </li></ul><ul><li>Focus changes form earning operating profit to cost of capital conservation. </li></ul>
  11. 11. Profit Margin in New Economy <ul><li>Profit margin in comparison to Customer volume and Customer satisfaction; </li></ul><ul><li>A low margin is as likely to be a measure of customer satisfaction, an investment in the future, or a reaction to a positive capital float than it is an indication of poor performance. </li></ul>
  12. 12. Cases: <ul><li>Wal-mart Vs. K-mart </li></ul><ul><li> ‘s negative working capital </li></ul><ul><li>Working of different Retail-marts </li></ul>
  13. 13. Case: <ul><li>Wal-mart Vs. K-mart </li></ul><ul><ul><li>Wal-mart has ↓ Gross Margin ↔ sales/ $ of its capital (fixed capital charge as well as working capital charge) ↑, i.e. conservation of Capital Charge. </li></ul></ul><ul><ul><li>As Capital charge ↓ so EVA ↑, hence SHW ↑ </li></ul></ul><ul><li> ‘s negative working capital </li></ul><ul><li>Working of different Retail-marts </li></ul>
  14. 14. Case: <ul><li>Wal-mart Vs. K-mart </li></ul><ul><li> ‘s negative working capital </li></ul><ul><ul><li>Cash Cycle = Operating Cycle – A/c Payable Period < 0 </li></ul></ul><ul><ul><li>Inventory Period ≈ 0 </li></ul></ul><ul><ul><li>A/c Receivable Period < A/c Payable Period </li></ul></ul><ul><ul><li>Hence, Positive float which can be invested in short term to increase earnings </li></ul></ul><ul><ul><li>Cash is generated in operation so, Working Capital Charge ≈ 0, which means EVA ↑ </li></ul></ul><ul><li>Working of different Retail-marts </li></ul>
  15. 15. Case: <ul><li>Wal-mart Vs. K-mart </li></ul><ul><li> ‘s negative working capital </li></ul><ul><li>Working of different Retail-marts </li></ul><ul><ul><li>Retail marts Branded goods -> Gross Margin ↓ (or sometimes negative), customer satisfaction ↑, probability of customer coming back for future purchase ↑; </li></ul></ul><ul><ul><li>Retail marts Value aided services -> Gross Margin ↑ customer willingness to pay for convenience ↑; </li></ul></ul><ul><ul><li>Portfolio of products is wide so risk of high loss ↓; </li></ul></ul><ul><ul><li>Sustainability of business ↑; </li></ul></ul><ul><ul><li>Hence, accounting loss can become real economic profits; </li></ul></ul>
  16. 16. Adjudge Modern Trends in New Economy <ul><li>Out-sourcing & Specialization; </li></ul><ul><li>New Connections; </li></ul><ul><li>New Capital; </li></ul>
  17. 17. Adjudge Modern Trends in New Economy <ul><li>Out-sourcing & Specialization; </li></ul><ul><li>New Connections; </li></ul><ul><li>New Capital; </li></ul>
  18. 18. Outsourcing Case: Cisco <ul><li>Outsourcing -> forming virtual corporations which are highly specialized in their value-adding activities. </li></ul><ul><li>Cisco has 36 plants but, only 2 is owned by Cisco and 34 others are specialized value adding centers. </li></ul><ul><li>Affect in P/L Statement (Burden Added) </li></ul><ul><ul><li>Cost of Materials and normal Operating Expanses </li></ul></ul><ul><ul><li>Cost of financing the manufacturing capital they employ on Cisco’s behalf </li></ul></ul><ul><li>Affect on Balance Sheet  Capital tied in fixed asset and operating asset decreases by a large extent; </li></ul><ul><li>Although Margin ↓ but Cost of Capital ↓ further and hence EVA↑ (due to outsourcing and specialization) </li></ul>
  19. 19. Adjudge Modern Trends in New Economy <ul><li>Out-sourcing & Specialization; </li></ul><ul><li>New Connections; </li></ul><ul><li>New Capital; </li></ul>
  20. 20. New Connections: <ul><li>Walled Structure  Borderless neural network; Linking customers, suppliers, employees and even competitors; </li></ul><ul><li>New Product Strategy  Maximizing Profitability over products entire life. </li></ul><ul><li>CRM  Customers benefiting from Both Pre and Post Sales, that increases convenience. </li></ul><ul><li>Performance measurement and Compensation  Based on how managerial decisions affect the company’s payoff pattern of future; not based on profit earned. </li></ul>
  21. 21. Adjudge Modern Trends in New Economy <ul><li>Out-sourcing & Specialization; </li></ul><ul><li>New Connections; </li></ul><ul><li>New Capital; </li></ul>
  22. 22. New Capital: <ul><li>Acquisition of customer </li></ul><ul><li>Research </li></ul><ul><li>Innovation </li></ul><ul><li>Brand building </li></ul><ul><li>Training </li></ul><ul><li>Experimentation </li></ul><ul><li>Human Capital </li></ul>Should be treated as asset to nurture not as expanse to minimize and control;
  23. 23. Conclusion: Why EVA® ? <ul><li>Speeds Decisions; </li></ul><ul><li>Increase Flexibility; </li></ul>
  24. 24. Conclusion: Why EVA® ? <ul><li>Speeds Decisions; </li></ul><ul><ul><li>Redefining and clarifying the measure of success; </li></ul></ul><ul><ul><li>Non-rationing approach </li></ul></ul><ul><li>Increase Flexibility; </li></ul>
  25. 25. Conclusion: Why EVA® ? <ul><li>Speeds Decisions; </li></ul><ul><li>Increase Flexibility; </li></ul><ul><ul><li>Bonuses are decoupled from budget </li></ul></ul><ul><ul><li>Flexible strategy for ambitious plans to achieve (So that Return on Capital is more than Cost) </li></ul></ul>
  26. 26. THANK YOU Question and Suggestions Invited By Sandip De