Eva Better Than Roi
Why EVA is better than ROI (ROCE, ROIC, RONA, ROA) and earnings, operating profit etc.
Equity investors should earn on their capital a return far over risk-free interest rate in order to induce and maintain capital in the company Therefore earnings should always be judged against the capital used to produce these earnings Earnings can be easily increased simultaneously worsening the position of shareholders e.g. if more capital is poured into a company although the return on capital is 5% or less (even lower than long-term government bond) Thus it is clear for most people that any earnings figure can not alone be a reliable performance measure (still some companies use EPS !?)
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Following slides focus on explaining why also return on capital alone is often an unreliable performance measure
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© Esa Mäkeläinen 12.3.1998
E-mail: Esa.Makelainen@iki.fi
EVA is a registered trademark of Stern Stewart & Co.
EVA vs. rate of return
There are two very good reasons why EVA is much better than ROI (RONA, ROCE, ROIC) as a controlling tool and as a performance measure
1. Steering failure in ROI Increase in ROI is not necessarily good for shareholders i.e. maximizing ROI can not be set as a target. (Increase in ROI would be unambiguously good only in the companies where capital can be neither increased nor decreased -> however we leave in a world where both operations are easily executed in almost all companies) 2. EVA is more practical and understandable than ROI As an absolute and income statement -based measure EVA is quite easily explained to non-financial employees and furthermore the impacts of different day-to-day actions can be easily turned into EVA-figures since an additional $100 cost decreases EVA with $100. (ROI is neither easy to explain to employees nor can day-to-day actions easily be expressed in terms of ROI) This latter benefit if often totally forgotten in academic discussion since it can not, of course, be visible in desk studies or
Equity investors should earn on their capital a return far over risk-free interest rate in order to induce and maintain capital in the company Therefore earnings should always be judged against the capital used to produce these earnings Earnings can be easily increased simultaneously worsening the position of shareholders e.g. if more capital is poured into a company although the return on capital is 5% or less (even lower than long-term government bond) Thus it is clear for most people that any earnings figure can not alone be a reliable performance measure (still some companies use EPS !?)
!
Following slides focus on explaining why also return on capital alone is often an unreliable performance measure
1
© Esa Mäkeläinen 12.3.1998
E-mail: Esa.Makelainen@iki.fi
EVA is a registered trademark of Stern Stewart & Co.
EVA vs. rate of return
There are two very good reasons why EVA is much better than ROI (RONA, ROCE, ROIC) as a controlling tool and as a performance measure
1. Steering failure in ROI Increase in ROI is not necessarily good for shareholders i.e. maximizing ROI can not be set as a target. (Increase in ROI would be unambiguously good only in the companies where capital can be neither increased nor decreased -> however we leave in a world where both operations are easily executed in almost all companies) 2. EVA is more practical and understandable than ROI As an absolute and income statement -based measure EVA is quite easily explained to non-financial employees and furthermore the impacts of different day-to-day actions can be easily turned into EVA-figures since an additional $100 cost decreases EVA with $100. (ROI is neither easy to explain to employees nor can day-to-day actions easily be expressed in terms of ROI) This latter benefit if often totally forgotten in academic discussion since it can not, of course, be visible in desk studies or