This paper will discuss the importance of measuring performance of balanced scorecard and economic value added. The crucial relation of the two disciplines which is a determinant of an organization’s overall financial performance. Every business organization has their own vision of how the company will be after a specific period of time. This vision is guided with a mission that dictates the decision of the company in the course of their operations. Mission and Vision must go hand in hand to ensure smooth sailing business operations and it entails the success of the organization once the mission and vision was embodied although out. Business practices must adhere to the guided policies mandated by the company’s mission and vision and the output can be measured by means of balanced scorecard (Businessballs.com N.D.).
Once an organization was able to take every guideline by heart and follows through, financial stability follows and in return promises steady revenue. On the other hand it is not enough that the business is thriving financially, but performance has to be measured as well to ensure balance between costs of capital and profit also known as economic value added or EVA (Valuebasedmanagement.net N.D.). By measuring this performance area of an organization, assessment of economic value based on profit can be achieved. In this paper, the positive impacts of measuring the two disciplines will be explained recommendations will be made with supporting fact that will prove its effectiveness.
Business Performance and Measuring Points
Every organization a business enterprise for example has to have a pre-defined performance measurement system which will determine how the company is doing during the course of its operation. Strategy is crucial in ensure performance of the business and measuring them is the key to identifying results of the company’s decisions. There are two methods to measure results one is by seeing how effective the mission and vision was in driving the organization to success. Another measuring method is the economic value added in which the financial balance is well defined to ensure profit margin against capital is at acceptable rate to realize net revenue.
Since financial aspects of the business is paramount to avoid short on cash flow, economic value added is the best measuring tool to use in exercising control. First is to be familiar in understanding the principles of EVA. It is as simple as net operating expenses, adjusted of tax minus charges incurred on opportunity cost based on the capital investment. Therefore the value obtained from the simple equation determines the real economic value of the company. Economic Value Added is a trademark of Stern Stewart & Co. a leading economic and management firm based in New York in the United States. They own the concept of EVA and offer their corporate client the service using this methodology to help identify financial and overall business performance. EVA works as an estimating tool to assess whether the revenue has exceeded or short of the minimum required rate of return set by the share holders. EVA serves many purposes such as measuring performance, motivating the managers, valuation, equity and securities analysis, organizational goal setting, bonus determination for employees, capital budget and communicating data for shareholders.
Given all the purposes served by EVA for the company it is fitting that this method is to he one to be used in order to map the overall performance of the company as a whole not only in the financial division of the business. The calculation is easy to decipher, look at the formula below to have an idea of how the economic value added results was obtained.
The formula above may look similar to other business planning tools, but the only difference is that capital investment cost is being deducted from the net profit s well. This entails excess revenue that can also be used for other means such as production expansion, purchasing new equipment, employee bonuses or corporate savings as contingency fund. Evidence that will testify to the effectiveness of this method is the company named Whole Food Market. The company is a leading distributor of natural and organic foods based in Austin, Texas in the United States. They were using EVA to evaluate their financial performance enabling them to make decisions from the results rendered by this measuring tool. Whole Foods is also using this method in determining how much they are going to allocate to compensation for their employees.
On a 9% average cost of their capital and 40% on tax rates from the period of September 24, 2006 to September 30, 2007, the table was set to determine EVA within the given period. From 2006 to 2007 the company showed positive gains $38 million on their EVA after capital and tax deductions. With that information on hand Whole Foods was able to decide if they would be opening new stores or if they have enough to do remodeling (Wholefoodsmarket.com N.D.).
With the success of Whole Foods in managing and controlling financial decisions, EVA became a helpful tool for the company in realizing where their company is going and how they are doing. It is recommended that economic value added methodology should be adapted by organizations in order to achieve effective control measures of the company’s finances. By following EVA method, our investors would be able to obtain the average return in stock market in a long term basis. It can also help them achieve stable alternative returns on their capital if EVA is utilized because if investors lost the alternative returns it also means losing their money (Mäkeläinen, Esa October 3, 1998).
In other words investors cannot afford to have lower average returns in any of their investments and to avoid that economic value added must be measured accurately to determine loss and gains on the investor’s capital. Theoretically speaking, economic value added is far better than any available measuring methods in explaining the economic value of the company. Our company should depend on the future EVA values in order to sustain continuous operation and ensuring positive gains.
The bigger the EVA values the bigger is the market value of the company and that entails higher stock price because positive growth on EVA drives the increase on stock price.
Companies like Nokia, Intel, Apple and Microsoft have high stock price because they were able to maintain above average book values. The confidence of existing and future investors rely on the market value of the company, if financial aspects of the business are not fully controlled or even measured accurately, chances are the financial status of the company will be devastated and will result to loss of revenue.
Businessballs.com (N.D.) balanced scorecard. Web Retrieved on February 4, 2012 from http://www.businessballs.com/balanced_scorecard.htm
Valuebasedmanagement.net (N.D.) Economic Value Added Web Retrieved on February 4, 2012 from http://www.investopedia.com/terms/e/eva.asp#axzz1lRnCwFEv
Wholefoodsmarket.com (N.D.) Economic Value Added Web Retrieved on February 4, 2012 from http://www.wholefoodsmarket.com/company/eva.php
Mäkeläinen, Esa (October 3, 1998) Introduction to Economic Value Added, EVA Web Retrieved on February 4, 2012 from http://www.evanomics.com/download/Intro.pdf