- EVA analysis is most useful to business owners and managers — or at least to owners and managers of small and medium-size firms — as a thinking tool. In other words, even if you don’t scratch out the numbers on the back of an envelope, EVA makes sense as a way to think about how you should run your business and whether it makes sense to make changes. Comparing your firm’s net income with the amount that you could earn by selling and then reinvesting the capital elsewhere is a useful concept.
One literary agent says, “Listen to the universe.” This suggestion, especially as it relates to the economics of running a business, is pretty darn good. You should listen to the economy when you think about your business, and EVA provides a tool for you to do that. For a business to make sense, it needs to return a fair share to each of its stakeholders: wages to employees; interest and debt service payments to lenders; a return to shareholders who invested capital; and then, as a practical matter, a little something left over for you, the owner. Indeed, in order for a business to make sense, it needs to pay more than just its capital charge.
- Although you can use EVA analysis to evaluate a business in its entirety, EVA analysis isn’t limited to that application. You can use EVA analysis, with a little bit of fiddle-faddling, to evaluate a business unit, a particular product line, your managers, and so forth.
This is really neat if you think about it. You can use EVA analysis to break your business into different profit activities. By using EVA analysis to look at the economic profit of these different profit activities, you can probably find those activities that should be emphasized because they produce an economic profit, and you can identify those activities that should be discontinued (perhaps) because they don’t produce an economic profit. You can evaluate customers and managers the same way.
If you want to do this more granular EVA analysis, work with a chart of accounts that supports more detailed income statements and balance sheets. In other words, if you’re going to break your business into two business units, use a chart of accounts that lets you easily see the income statement for each business unit. In a similar fashion, use a chart of accounts for your balance sheet that lets you see the capital investment for both business units. Remember that any line item that you want to appear on an income statement or balance sheet needs its own account in the chart of accounts.