Financial Times

EPS measurement as company performance could be misleading

Traditional methods of measuring a company’s performance such as Earnings Per Share (EPS) can be very misleading, according to an expert from the Indian Institute of Management in Bangalore. Speaking at a CFO Forum organised by the Institute of Chartered Accountants of Sri Lanka (ICASL) this week, Professor P.C. Narayan said using Economic Value Addition (EVA) as a performance measurement tool is the ultimate litmus test of any company’s success.

He said he has already used the EVA on smaller companies and is planning on using it for larger corporations in India to ascertain if those companies are enjoying premiums in the market which they should not.

Professor Narayan said methods such as EPS may cause the management to refrain from issuing equity at times when the company really needs it. Other concerns include the possibility of fabricating EPS gains by using more debt than prudent as well as accepting weak projects that happen to be financed by debt.

EVA was developed by Stern Stewart which defines it as a financial performance measure that comes closer than any other to capturing the true economic profit of an enterprise. EVA is also the performance measure most directly linked to the creation of shareholder wealth over time. Put simply, EVA is a net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. As such, EVA is an estimate of true ‘economic’ profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenders could gain by investing in other securities of comparable risk.

“The basic premise of the EVA is that managers are obliged to create value for the firm’s investors”, Professor Narayan said. He added that investors place money in a company because they expect returns. There is also a minimum level of profitability expected by investors called ‘Capital Charge’ A company generating a return less than the capital charge is economically not acceptable.

EVA is calculated through a simple formula. EVA equals the Net Operating Tax After Profit (NOPAT) minus the Capital multiplied by the Capital Charged Rate (CCR). In simplified form, EVA = NOPAT – Capital x CCR. Professor Narayan explained that the EVA can be calculated at the end of the financial year or done quarterly or monthly, by taking the capital cost proportionately.

Professor Narayan said the EVA should be implemented since it is an indicator of whether a company has created or destroyed its profits. He said it is a consistent way to improve a firm’s financial performance and aligns the interests of management and investors. EVA is also the most appropriate measure of shareholder earnings. He added that EVA requires consistent and continuous improvement which in turn will improve stock price.


 
Top to the page  |  E-mail  |  views[1]
 
Other Financial Times Articles
> IRD to tax Golden Key and depositors
> Hedging case takes another turn
> SEC refers Eswaran deal in Asia Cap to CB
> Plantation Cos. fail to pay lease rental
> CB cancels Seylan sale deal, extends board term
> Job losses amidst worker shortage
> Rare flowers and seeds of the tea bush
> COMMENT- Whistle-blowing: Will it work?
> Corporate Governance: Lessons from other jurisdictions
> EPS measurement as company performance could be misleading
> Swine Flu economic effect global- MTI
> World leaders approve Global Jobs Pact
> Sri Lankan-born American scholar explores trade and peace
> World's first 'Fair Trade' rubber glove by Lankan firm
> Prof. Munasinghe at Biz Club
> Emerging markets are Nokia’s next growth area
> Need for whistle-blowing hotline facilities emphasized
> Haycarb sees prospects in India, Thailand and Indonesia
> Lanka Salt records 99% profit increase for 2008
> SEC to raise financial media capability
> CB's FIU gets membership in Egmont Group
> CCC meeting looks at emerging opportunities
> US interference in the IMF deplorable - Minister Amunugama
> Hayleys profit drops 26%
> Caritas completes tsunami work worth over Rs 11 billion
> Chartered Institute of Logistics celebrates 25 years by opening doors to youth
> Seylan Merchant shows sharp losses in 1Q ‘09
> Tourism industry’s ‘Small Miracle’ unveiled
> SC calls for discipline at SLI
> Private firms get access to more funds
> Carbon Finance to fight climate change
> NTB in major forex loss, share rise seen hampered
> Seminar on trade terms risks, obligations
> Pest, disease and drought resistant tea trees coming out
> Cost of doing business in Sri Lanka reducing with the end of war -- Amunugama
> Travel warnings against Sri Lanka on the way out, says tourism sector

 

 
Reproduction of articles permitted when used without any alterations to contents and a link to the source page.
© Copyright 2009 | Wijeya Newspapers Ltd.Colombo. Sri Lanka. All Rights Reserved.| Site best viewed in IE ver 6.0 @ 1024 x 768 resolution