Wednesday, August 31, 2011

Huddle Up...Here's the Play

Two weeks ago, I wrote about having a single corporate goal. Economic Value Added (EVA) is a great metric that can align the organization around a single financial goal. It also has a great correlation with market value (for public firms, according to the developers, Stern Stewart) and similarly enterprise value (for private firms). For employee-owned companies, it seems a must. EVA can be calculated on a monthly basis, whereas the stock value for an ESOP is figured out annually. For more info, see 4ward Associates. Because it's monthly, your employees will be interested in whether EVA is increasing or decreasing. I used to have employees ask me about EVA within 2 days of month-end. They were excited to know what it was doing. They knew how to contribute to it on a daily basis. It also helped that they had a bonus tied to it.

EVA helped drive a lot of the right behaviors and decisions. (It can lead to some short-term problems but this is where leadership exists to keep the focus on the long-term with some investments in equipment, inventory, personnel, etc.) We had employees asking questions about such things as increasing inventory (bad for EVA) and higher freight expenses (bad for EVA). It opened a dialogue to explain that the inventory allowed us to charge more, and at a rate greater than our carrying cost, and it allowed us to explain that we're expediting materials in to attain an expedite fee from our customers. It cued the A/R clerk whether to acknowledge a request for longer terms from a customer or fight for payment on an unauthorized deduction from an invoice. We could even calculate a rough-cut EVA by customer or market segment to help us evaluate strategies in those markets.

EVA is the difference between net operating profit after taxes (NOPAT) and a portion of the capital investment. The capital factor became a threshold for evaluating a lot of options. For capital, we could look at the base equity, but more often we factored in most of the assets less most of the liabilities. If we could increase income beyond the 20% cost of A/R or inventory, then it was worthwhile. 20% is a typical weighted cost of capital for many private firms. It's the expected rate of return for investments.

Because EVA is a combination of the income statement and the balance sheet, it's a great metric for teaching people how they contribute to the growth in the value of the company. Because it's a combination, everyone has some influence on its movements. A line of sight is easily created. People know exactly what their responsibility is in the playbook of your business.

For those practicing the Great Game of Business, and having weekly huddles, a monthly report on EVA is a plus. Not only will employees have an eye on the scorecard with relation to profits, but they'll know if they're increasing the value of the company. Now for ESOP's, that's a must.

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