EVA a solid measure of business performance

What is this Economic Value Added (EVA) that some business people and economists get so excited about?

It is a method of measuring the performance of a business and was basically invented by Joel Stern and his partner, Bennett Stewart.

They started from the proposition that the object of a business is to take the capital of investors and use it to create wealth.

So EVA calculates how much capital has been invested in a business over its lifetime and then looks at the return achieved on that investment.

It requires all a company's investments, including goodwill and intangible assets like brands or R&D, to be put on the balance sheet, not written off, to emphasise the fact that they have to make a return.

It is an unforgiving technique that gets behind the facade of profit announcements.

For instance, last year Carter Holt Harvey announced an annual profit of $73 million, which, while modest, was a big improvement on the $15 million loss reported the year before.

But Stern Stewart's calculations showed that when the cost of the capital invested in CHH was taken into account, its EVA for the year was about minus $1 billion.

As well as helping investors to assess a company's performance, EVA has value in two other areas.

First, it allows companies to allocate capital to those ventures which will produce the best return.

Second, it provides a solid footing for setting remuneration on the basis of return to investors.