Implementing the EVA system

Implementing the EVA system involves several; steps which are briefly described below:

Develop Top management Commitment: A crucial requirement of EVA system is top management commitment. To build this commitment the top management should be thoroughly in the theory and practice of EVA.

Customize the Definition of EVA: A cross functional team of executive should arrive at a customized definition of EVA – in terms of NOPAT, CAPITAL, and EVA calculations that is best suited to the form considering its informational needs and accounting system.

Identify EVA Centers: A firm may be divided into EVA centers – these are responsibility centers for which individuals EVAs will be calculated on a continuing basis.

Analyze the Drivers of EVA: EVA must be linked to various financial and non-financial variables which drive it. An understanding of these drivers helps mangers to appreciate how their actions influences value.

Tailor an Incentive Compensation System: Te incentive compensation system must align the interest of managers with shareholders. Ideally, it should make managers think, act, and be compensated like owners.

Train all the Employees: The employees at all levels of the organization must be trained in the basics of EVA. They must know how EVA is calculated what EVA means, and how their actions impact on EVA.

Limitations of EVA

EVA has gained immense popularity and currently is one of the hottest topics in finance. It is considered to be a better measure of performance compared to traditional measures like earnings per share and profit after tax. Many successful organizations argue that the use of EVA has sharpened their value management programs.

Notwithstanding eth above claims, EVA has its own limitation. Perhaps the most serious shortcoming of EVA is that while it helps firms in achieving higher business unit efficiency it does not encourage collaborative relationship between business unit mangers.

Globalization, liberalization, and technological advance make it imperative for firms to enhance their efficiency and also to transform themselves by exploiting newer opportunities that capitalize on their core competencies. For example, Eastman Kodak is trying to harness recent developments in electronics to shift its trust to digital photography and Monsanto is seeking to transform itself from an old line chemical manufacturer into a genetics engineering and pharmaceutical company. To accomplish such transformations, firms must leverage their core competencies and resources. Inter alia, this requires a shared corporate agenda and greater collaboration among business units. Unfortunately, EVA like systems, given their emphasis on improving business unit performance, do not encourage collaborative endeavor. This is the paradox of a large diversified firms which is organized into free standing business units to provide administrative clarity, heighten accountability ,and sharpen incentives. As CK Prahalad says: he more valuable is the collection of individual business when combined in the same portfolio the less effective are divisionalized measures in capturing that value and creating incentives for future corporation and growth opportunities.

A second limitation of EVA is that it is not perfect measure. True, it is a better measure than conventional measures like EPS, PAT, and RONW. Still it is far from being a perfect measure. As Michael Jensen says: Thus, while EVA is the best flow measure of performance currently known, it is not the universal answer to the search for the perfect performance measure. Perfect measures of capitalized value will never be found because value cannot be known with certainty until after a project has run its course to competition and shut down.