EVA: a profit on the books, but no value created — where the line runs

Economic value added (EVA) is a company's profit after a charge for all the capital it uses, equity included, has been deducted. The accounting statement subtracts interest on debt and stops there: it treats shareholders' money as free. EVA adds the missing line and answers a question the income statement never asks: did the business earn more than an investor would have made simply by keeping the money somewhere of comparable risk? If positive net profit does not cover the required return on the capital invested, the company keeps operating, pays salaries and reports growth — and all the while destroys value.

How the calculation works

The construction rests on three elements. The first is net operating profit after tax (NOPAT): the result of the core business, stripped of interest payments and one-off financial effects, less tax. The second is invested capital: the amount that owners and lenders have actually left in the business. The third is the weighted average cost of capital (WACC): the required return, weighted by the shares of debt and equity.

EVA = NOPAT − WACC × invested capital.

Interest on loans is excluded from NOPAT not in order to forget about it, but to avoid deducting it twice: the cost of debt is already built into WACC. This symmetry is the main technical discipline of the calculation. Break it, and you get a number that measures nothing.

An equivalent form is more useful for intuition: EVA = (ROIC − WACC) × invested capital. The difference between the return on invested capital and its cost is called the spread. A positive spread means scale works in the investor's favour: every additional rouble put into the business adds value. A negative spread turns the logic of growth upside down — expanding a business with such economics destroys value all the faster the better sales go. Hence a practical conclusion that management will not welcome: with a negative spread, the right strategy is to shrink invested capital, not to fight for revenue.

Why net profit answers a different question

Profit is what remains after explicit costs. The cost of capital is not one of them: nobody sends the company an invoice because a shareholder chose not to sell their stake and move the money into a risk-free instrument along the lines of OFZ. This is an opportunity cost, and by definition it does not appear in the financial statements. That is why a company with impressive profits and a bloated balance sheet can show negative EVA for years — especially a capital-intensive one, with expensive assets and a long operating cycle.

A related gap lies between the book and the market basis. EVA is calculated from invested capital as recorded on the balance sheet, while the market values the company through its enterprise value; the difference between the two is market value added, the market's estimate of the sum of all future EVA. We have a separate piece on the difference between what the price shows and what the calculation shows: price and value of a company. It also makes clear why fair value and market capitalisation are different concepts, not just different words.

Adjustments: where the calculation becomes contentious

The book basis is rarely usable without amendments. The typical set of adjustments: capitalise expenses that accounting writes off immediately even though they have a long-term effect — research, development, brand building; add reserves and accumulated write-offs back to capital; treat leases as a form of financing; exclude non-operating assets and idle cash balances. Each such adjustment changes both NOPAT and the capital base — and each opens room for massaging the result.

This is the flip side of the metric: EVA is not observed, it is constructed. An analyst calculating it for an external valuation has to disclose their assumptions — otherwise comparing companies with one another becomes meaningless. For calculations on Russian issuers, the financial statements are collected in the financial reports section, and the publication schedule is in the events calendar.

What EVA is used for in practice

There are three main applications. In valuation, it serves as a bridge between the financial statements and value: the discounted stream of future EVA plus current invested capital gives a valuation that is mathematically equivalent to a discounted cash flow model but more transparent about where the value comes from; at the far end of the horizon, the calculation hinges on the terminal value and on the assumption that competitive pressure gradually squeezes the spread down to zero.

In management, it serves as a basis for executive pay. Linking bonuses to EVA rather than to profit removes the incentive to pile up assets for the sake of scale: capital stops being free for whoever controls it.

In the analysis of individual decisions, it serves as a filter for projects. The logic is the same as in assessing customer payback, discussed in our piece on LTV and CAC: as long as the return does not exceed the cost of the money raised, growth only makes the bill bigger.

Where the metric falls short

EVA looks at a completed period and penalises investments whose returns will come later: a company in the middle of a major construction programme will show negative EVA precisely because it is doing everything right. For financial institutions, the notion of invested capital becomes blurred — for a bank, debt is raw material, not financing. For companies whose main asset is not on the balance sheet, the book basis is understated, and the spread comes out inflated through no merit of their own. And no version of the calculation tells you whether the spread is sustainable: that is a question of competitive advantage, not arithmetic. To set the result against the market picture, use share prices and the dividends section — distributing profit and creating value are related, but they are not the same thing.