more-arw search

Q&A Forum

Should an SMB focus more on ROI or EVA?

Jeff Andrews's Profile

ROI vs EVA - Return On Investment vs Economic Value Added For SMBs

Answers

Topic Expert
Regis Quirin
Title: Director of Finance
Company: Gibney Anthony & Flaherty LLP
LinkedIn Profile
(Director of Finance, Gibney Anthony & Flaherty LLP) |

Your question has six words and three acronyms. Can you define the acronyms to avoid confusion?

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

To further refine the definition, ROI for example can be used multiple ways by multiple end-users. Thus Marketing can obtain a different ROI then Finance for the same product/service/widget.

Which group are you talking about?

Sarah Jackson
Title: Associate Editor
Company: Proformative
(Associate Editor, Proformative) |

Proformative offers some great courses on Valuation and various methods:

https://www.proformative.com/sitesearch?type=Courses&keywords=valuation&op=Search

Best... Sarah

Topic Expert
Joseph Ori
Title: CEO
Company: Paramount Capital Corporation
(CEO, Paramount Capital Corporation) |

Depending on the industry and size of co, EBITDA, ROI, ROE and other ratios.

Topic Expert
Jake Feldman
Title: Managing Director
Company: Global TaxFin Advisory Group LLC
(Managing Director, Global TaxFin Advisory Group LLC) |

Hi Jeff,

Typically, a Small and Medium Business likes to keep things simple, so they would tend to favor using Return on Investment ratios rather than the Economic Value Added concept. (ROI is often also used to mean the IRR from a DCF calculation but that is not the meaning I use here.) Academics prefer EVA because it can be shown to be equivalent to NPV but practitioners sometimes have difficulty understanding the relative comparison of either EVA or NPV. For example, if I tell you that project A has a 20% ROI while B has a 10% ROI, you can intuitively feel the relative value between the two. However, if I tell you that Project A has an NPV or EVA of 1000 compared to project B of 500, is A really twice as good as B? Oh, did I forget to tell you that both projects have a billion dollars invested? In other words, people have difficulty understanding scale with EVA or NPV.

While ratios are helpful for cross-sectional or time-series comparisons, when it comes to choosing projects, a DCF/NPV approach is still the superior criterion.

Hope this helps. If you'd like to see some readings about EVA, please send me a note.

Jake

Topic Expert
Barrett Peterson
Title: Senior Manager, Actg Stnds & Analysis
Company: TTX
(Senior Manager, Actg Stnds & Analysis, TTX) |

The answer varies a little depending on the use...project selection or operating performance evaluation. I like an "EVA lite" approach for operating performance evaluation as it explicity recognizes the cost of equity capital not recorded under accounting rules. The trick is picking the cost of equity capital, including factoring the degree of financial leverage present. For a small/medium business, simple is fairly essential. Certain variations of EBITDA ratios are useful, but more complex for some to follow, and need to compare to an investment measure and provide an "appropriate" or higher return.

david waltz
Title: Assistant Treasurer
Company: Integrys Energy Group
(Assistant Treasurer, Integrys Energy Group) |

Assuming we are using ROI in the sense of Jake's example (IRR et al), the two measures can be related, so it is not an either/or situation. EVA is calculated as the value added over the cost of capital: EVA "rate" = ROI - Cost of Capital. The resulting rate is then multiplied to generate an EVA value (500 or 1000 in the example).

Georg Fendt
Title: CFO
Company: TÜV SÜD Product Service
LinkedIn Profile
(CFO, TÜV SÜD Product Service) |

Both are useful indicators and it depends on what you are trying to compare/evaluate over time and for what purpose. In particular EVA depends on a series of adjustments/assumptions that are specific to each organization (for example treatment of R&D expenses) and therefore it could get complicated. If you for example decide that leasing is capitalized in your EVA calculation you will get different figures than if you don't treat leasing in such a way.
What is really important is to evaluate the free cash flow over time originated from the SMB.
In short, both ROI and EVA are useful for specific purposes. EVA might require additional work to provide #transparency and it might reflect the accounting value creation depending on adjustments/assumptions and this should be considered to avoid wrong #decisionmaking.

Mark Matheny
Title: VP - FInancial Planning and Analysis
Company: Novolex (formerly Hilex Poly)
(VP - FInancial Planning and Analysis, Novolex (formerly Hilex Poly)) |

I agree with Barrett. I like an "EVA lite "approach. I find it allows you to think through the key drivers of the decision without going all the way through all the complexities of an entire EVA calculation. At the end of the day, done correctly the two methodologies should get you to the same place the majority to the time.

Gerry Anderson
Title: President and Founder
Company: Logicon Solutions
LinkedIn Profile
(President and Founder, Logicon Solutions) |

I would agree with Georg Fendt. It depends on what you are trying to measure. While ROI and EVA have a focus pertaining to capital, it might not measure the 'heartbeat of your business' like customer churn, lifetime customer value, customer acquisition costs. You need to first define what you are trying to monitor or measure and then choose the most appropriate metric. For example, a ruler and a thermometer are both measurement instruments but one measures space while the other measures temperature.

Christine Russell
Title: CFO
Company: Evans Analytical Group (EAG)
(CFO, Evans Analytical Group (EAG)) |

ROI for capital purchases, profit for overall company (ebitda if it is a private equity firm, eps if it is public, revenue and operating income if it is venture based).

Bill Gibbons
Title: President and Founder
Company: Mercury Capital Analytics
LinkedIn Profile
(President and Founder, Mercury Capital Analytics) |

EVA would be preferable inasmuch as it considers scale, but for an SMB it is difficult because of its cost of capital component whose complexity eludes most small/mid-size groups. Truthfully, cost of capital, as central as it is to finance theory, and whose inverse drives the value if the firm, is problematic even for the big guys for a number of reasons including a "risk free rate of return" that continues its distorted values from the last several years, and the many inconsistencies with which the other factors in the C of C formula are applied. For comparing capital performance among entities, or for a single entity over different time frames, IRR is better than ROI because of the related difficulty of having to come up with sound discount rates for ROI. The reality is that effective financial analysis is challenging because there are several metrics to be considered, each with its own important perspective. The need is to weight and combine the various metrics into a comprehensive "grade" indicating whether the firm is, in fact, gaining or losing economic value, just as EVA attempts to do but fails because of the complexity and unreliability of C of C calculations. I've felt the need to build my own model for SMB analysis, and have weighted and combined the following eight variables (in order of importance): return on invested capital, year-over-year growth in free cash flow, asset turnover, earnings stability, sales variance from plan, cash conversion, debt/equity, and interest coverage. Economic value is created as the firm establishes a record of efficiently deploying its capital, and it is essential for the firm to define and track this over time. It's unfortunate there's no practical and reliable standardized tool for doing this across the finance profession.

14453 views
Topics

Get Free Membership

By signing up, you will receive emails from Proformative regarding Proformative programs, events, community news and activity. You can withdraw your consent at any time. Contact Us.

Business Exchange

Browse the Business Exchange to find information, resources and peer reviews to help you select the right solution for your business.

Learn more

Contribute to Community

If you’re interested in learning more about contributing to your Proformative community, we have many ways for you to get involved. Please email content@proformative.com to learn more about becoming a speaker or contributing to the blogs/Q&A Forum.