ECONOMIC VALUE ADDED

A concept critical in evaluating the performance of any business is economic value added. In generic terms, value added refers to the additional or incremental value created by an activity or a business venture. Economic value added is a refinement of this concept – it measures the economic rather than accounting profit created by a business after the cost of all resources including both debt and equity capital have been taken into account.

Economic value added (EVA) is a financial measure of what economists sometimes refer to as economic profit or economic rent. The difference between economic profit and accounting profit is essentially the cost of equity capital – an accountant does not subtract a cost of equity capital in the computation of profit, so in fact an accountant’s measure of income or profit is in essence the residual return to that equity capital since all other costs have been deducted from the revenue stream. In contrast, an economist charges for all resources in his computation of profit – including an opportunity cost for the equity capital invested in the business – so an economist’s definition and computation of the profit is net above the cost of all resources.