What is the meaning of EVA / Residual Income?


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Residual Income

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 EVA/ Residual Income-

  • Creating value for shareholders is now widely accepted as the dominant corporate objective.
  • Fortune magazine called it “Today’s hottest financial idea and getting hotter”
  • Management Guru Peter Druker called it “It is a measure of total factor productivity.”
  • EVA is essential the surplus left after making an appropriate charge for the capital employed in the business.
  • Formula-
  1. EVA= NOPAT – (ko x capital employed)
  2. EVA= PAT – ke. Equity
  • EVA= Capital (r – ko)

Where,

 

EVA= Economic Value Added

ko= cost of capital [weighted average cost of capital]

r= return on capital

NOPAT= net operating profit after tax

PAT= profit after tax

  • Steps for Implementing EVA

Develop top management commitment

Customize the definition of EVA

Identify EVA centers

Analyze the drivers of EVA

Tailor an Incentives compensation system

Train all the employees

 

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