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Understanding Economic Value Added (EVA) for Effective Cost and Revenue Management

In this session led by Professor William F. O’Brien, explore the framework of Economic Value Added (EVA®) as a robust measurement alternative for shareholder value. Learn about the key elements of managing costs and revenues, including the costs of debt and equity financing, and how adjusting net operating income can help determine EVA. This session emphasizes the implementation of EVA as a planning tool, explores corporate examples, and discusses ways to enhance EVA through profitability and capital investment strategies, aligning business objectives with stakeholder satisfaction.

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Understanding Economic Value Added (EVA) for Effective Cost and Revenue Management

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  1. Managing Costs & Revenues Professor William F. O’Brien, MBA, CPA Spring 2012

  2. Session 4 EVA® The Goal

  3. Economic Value-added AnalysisEVA® • Measurement Alternative for Shareholder Value • Elements MANAGING COSTS AND REVENUES-2012

  4. Sources of Capital -Debt -Equity Capital Buys “Stuff” “Stuff” Generates Income Let’s Define EVA® When the Cost of Capital is less than the Operating Income from that Capital, you create EVA®!!! MANAGING COSTS AND REVENUES-2012

  5. EVA® Elements • Cost of Debt Financing • Cost of Equity Financing • Components of Capital • Adjusted Net Operating Income MANAGING COSTS AND REVENUES-2012

  6. Cost of Debt Financing • Interest Expense • After-tax Impact • Consider all Debt, Excluding A/P MANAGING COSTS AND REVENUES-2012

  7. Cost of Equity Financing • Shareholder Hurdle Rate • Price Appreciation • Dividend Rate • “Six Percentage Point” Rule MANAGING COSTS AND REVENUES-2012

  8. Components of Capital • Net Working Capital • Net Long-lived Tangible Assets • R & D Spending • Employee Development Spending MANAGING COSTS AND REVENUES-2012

  9. Adjusted Net Operating Income • Substitute R&D and Employee Development Costs with Annual Amort. • Use Net Income from Continuing Operations • Adj. Net Op. Income Minus Cost of Financing Equals Economic Value Added MANAGING COSTS AND REVENUES-2012

  10. EVA® Uses • Planning Tool • Business Unit Evaluation • Incentive Compensation Base • Merger and Acquisition Analysis • Capital Asset Analysis MANAGING COSTS AND REVENUES-2012

  11. Corporate Examples • CSX • Quaker Oats MANAGING COSTS AND REVENUES-2012

  12. Ways to Raise EVA® • Increase Profits • Reduce Capital Spending • Reduce Investment in Working Capital • Increase High-margin Capital Investments MANAGING COSTS AND REVENUES-2012

  13. EVA® Implementation • Top management buy-in • Make it a way of life • Implement Gradually • Keep it Simple • Train the users MANAGING COSTS AND REVENUES-2012

  14. Theory of Constraints • The Concept • The Process • The Measures MANAGING COSTS AND REVENUES-2012

  15. The Concept • Presented in Eliyahu Goldratt’s The Goal • The goal of a business is to make money…consistent with stakeholder satisfaction • Continuous flow • Avoid the “herbies” • Eliminate the bottlenecks first MANAGING COSTS AND REVENUES-2012

  16. The Process • Identify the constraints • Exploit the constraints (reduce the bottlenecks) • Subordinate everything else • Elevate the constraints (remove the bottlenecks) • Reiterate the process MANAGING COSTS AND REVENUES-2012

  17. The Measures • Throughput - Net income • Inventory - ROI • Ops. Expenses - Cash Flow MANAGING COSTS AND REVENUES-2012

  18. Critical Questions from “The Goal” • What is the modified goal of “The Goal”? • Apply the “What” and the “How” to Alex. • What are Herbies…the boy and the process? • Is Jonah a crutch or catalyst? • Define Lou’s ethical dilemma. • Identify three critical measures from the book. • What’s your “Four on the Floor” from “The Goal”? MANAGING COSTS AND REVENUES-2012

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