For more than a decade, a powerful management tool has been used in the United States, designed to measure how efficiently companies make use of the capital they obtain from lenders and investors, as well as how to analyze asset productivity consistent. In this way, thanks to these measurements and analyzes, better decisions can be taken when motivating managers and company personnel.
This tool is called EVA, which stands for Added Economic Value, as it is an integral financial system created to measure the true profitability of companies and to remunerate their executives, managers and employees based on real growth. which has generated for the companies that have implemented it a faster and more lucrative growth than that of its competitors.
In an increasingly competitive world, in which the local markets have had to face the enormous external pressures and, to the continuous and unpredictable changes of the international market, the profitability of a company, the rotation of its assets and, ultimately, its market value increasingly depends on fast and flexible responses that adjust to changing environmental conditions.
To take the lead, many of the world's largest and best-managed companies have embraced this company-wide, incentive-based financial and compensation management system that has not only changed the way chief executives audit the development of their companies, but also the way they manage it.
EVA is making a difference in the business world, since it allows companies that implement it to optimize management and increase the wealth they generate. According to the experience of tree companies such as Coca Cola, Lilly, ATT, Siemens, Unilever, Marriot, among many others, the main advantages of this tool are:
- It can be applied to any type of company, regardless of its activity and / or size. Its calculation does not require complexities, being therefore easy and quick to understand and apply. It allows to measure in a more precise way the wealth obtained, from the Shareholder perspective. It allows evaluating any department, business unit or subsidiary of a company. It is easily understandable by any manager or employee. It enables highly effective measurement for the purposes of its application as a system of monetary incentives for managers and employees of the organization. Avoid short-term practices that end up deteriorating in the medium and long term the performance of the company.
The EVA is the result of subtracting from the ordinary profits of the company or business unit, before interest and after taxes (BAIDI), the product of multiplying the book value of the asset by the average cost of the liability. Another way to calculate it is by multiplying the book value of the asset by the difference between the return on the asset and the average cost of the liability.
By focusing attention on the profits that remain after deducting the cost of all capital, the EVA reveals the true performance of a company by providing its executives with new and more valuable financial information that they can apply in making their business decisions, from the acquisition or disposal of assets to market planning, project budgeting and product creation.
While linking employee compensation to constant improvement based on EVA can lead to amazing results, much more so if we combine EVA with the Kaizen continuous improvement system.
For now we can say that Coca Cola has been using the EVA system for more than twenty years, achieving during this period being one of the fastest growing and profitable companies worldwide. Of course, it was not the EVA by itself that allowed such important results, but it served as a guide in the daily decision-making regarding marketing, production and financial issues.
Since the late 1980s, more than 500 blue-chip companies have embraced the comprehensive management model created by Stern Stewart, rewarded with high-level increases in performance.
As previously stated, many Japanese and American companies combined EVA with continuous improvement systems, including Kaizen, and / or Just in Time, thereby achieving a better measurement of the achievements obtained, in addition to rewarding and motivating the personal for such varieties.
At the Latin American level, companies such as Vitro from Mexico, Brahma and Globopar from Brazil, Sanford from Colombia and the main Coca-Cola bottler in Latin America (Panamco) led the way in the implementation of the EVA.
EVA objectives
With the use of the EVA, the aim is to solve a large part of the limitations presented by other measurement instruments such as:
- Market price of shares Net profit Dividend Cash flow Return on Investment or on Assets Return on equity
Thus, the EVA has among its characteristics and benefits:
- To be able to be calculated for any type of company, regardless of its activity or size. To be able to apply both to a company as a whole, and to its business units separately. In its calculation, all the costs that occur in the company, among which is the cost of capital contributed by the owners. It duly takes into account the risk with which the company operates. It contributes to discourage practices and policies that harm the company both in the short and long term. Impact that creative accounting can have on certain accounting data, such as profits. Be reliable when trying to compare data from various companies. It is easy and fast to calculate. It presents a high level of clarity.
Strategies to increase EVA
There are five ways to generate greater added economic value consisting of:
- Improve the efficiency of current assets. It is about increasing the return on assets without investing more, achieving this by increasing sales prices, or reducing costs, or both measures simultaneously, with another possibility being an increase in asset turnover.. This clearly shows the wide repercussions of applying Kaizen and / or Just in Time as a way to reduce costs, increase asset turnover through a systematic reduction in inventories, and the possibility of achieving an increase in prices thanks to a substantial improvement in the levels of quality and customer service. Kaizen's focus on the systematic elimination of waste undoubtedly leaves its positive consequences in increasing the EVA.Reduce the tax burden through tax planning and making decisions that maximize tax deductions and deductions. Increasing investments in assets that exceed the cost of liabilities. By reducing assets, in order to decrease the amount over which financing cost applies. Both Kaizen and Just in Time contribute by reducing inventories (both supplies and products in process and finished), the reduced need for physical spaces and monetary assets; to the reduction of business assets. Also the reduction of the total cycle of the process is an advantage granted by the Kaizen in reducing the credits granted.Reduce the average cost of the liability so that the deduction made to BAIDI (Profits before Interest and after Taxes) is less. The application of Kaizen by generating a lower need for funds, in addition to achieving an increase in flow via lower expenses (due to the systematic elimination of waste) and higher income (via a considerable increase in the quality of products and services, attention to customers and higher levels of satisfaction) results in greater financial solvency, and consequently a better credit rating and a lower cost of capital.in addition to achieving an increase in the flow via lower expenses (due to the systematic elimination of waste) and higher income (via a considerable increase in the quality of products and services, customer service and higher levels of satisfaction) results in a greater financial solvency, and consequently a better credit rating and a lower cost of capital.in addition to achieving an increase in the flow via lower expenses (due to the systematic elimination of waste) and higher income (via a considerable increase in the quality of products and services, customer service and higher levels of satisfaction) results in a greater financial solvency, and consequently a better credit rating and a lower cost of capital.
Applying a strategy that allows an adequate combination of the ways to increase the EVA, significant increases can be achieved for the benefit of both the shareholders or owners, as well as the managers and employees of the company.
The Added Market Value
The EVA is complemented by another indicator that duly takes into account the future prospects of the company. This indicator is called Added Market Value, calculating it from the market price of the shares.
This price takes into account the possible generation of future income, which is why the joint use of the EVA and the VMA (Added Market Value) is recommended, since the first focuses on the income generation capacity of the past year, while the second is not only based on income already incurred, but also measures the capacity to generate positive income flows in the future. An important difference between EVA and VMA is that the former is calculated without considering extraordinary results, while the VMA increases when the company achieves positive extraordinary results, and decreases when extraordinary losses occur.
This VMA is calculated by subtracting from the market value of the shares the amount that the shareholders contributed to the company. The market value of the shares is the market price of the shares. (For those companies that are not listed on the stock exchange, they must have a purchase offer from the company for the purposes of their calculation). The best way to increase the Added Market Value consists of the same strategies and techniques applied to increase the value of the EVA.
Conclusions
Companies are in possession of new instruments and systems that facilitate not only the calculation of their ability to generate value, but also to use it in order to incentivize and motivate their managers, managers and employees in order to achieve consistent and long-term growth. in the income and capital contributed by the shareholders and their owners.
The EVA is precisely a sophisticated financial instrument but at the same time easy to use in order to achieve the objectives set out above, but also a powerful tool that encourages greater employee participation and generates incentives for continuous improvement.
The fact of being easy to understand by any manager, the possibility of being calculated by any company beyond its size and type of activity, the fact of taking into account all the resources and their cost, and Allowing managers to use this information not only to manage benefits but also existing assets in the company, are some of the most important and fundamental advantages to which the implementation of EVA contributes.
The combination of EVA with Kaizen produces a synergy that generates important benefits for the company. We call this new way of managing the company “K + E”, and many companies both in Japan and in the West are already reaping the results of such a management strategy.
Business reengineering can generate a quantum leap in EVA, but only Continuous Improvement can consolidate, maintain and expand the value of EVA in the long term, therefore the intimate relationship between EVA and Kaizen. On the other hand, carrying out continuous improvement not only requires measurements of productivity, quality, costs and satisfaction rates, but it is also essential to have values from which suitable means can be implemented for the motivation and incentive of managers and employees, matching their interests with those of the shareholders and owners.
Bibliography
EVA - Oriol Amat - Management 2000 - 1999
Kaizen - Detection, prevention and elimination of waste - Mauricio Lefcovich - 2004
Cost Reduction - Mauricio Lefcovich - 2005
The creators of wealth in Latin America - Anne Fisher - El Cronista Américas / Fortune - Vol. 2 Nº 6 - 1998
The process of creating value in the company - Mark Scott - Deusto - 1999
