Shareholders arethe owners of the company; they invest money into the company hoping for anincrease in stock valuation which increase their wealth. That’s why the topobjective for most companies are maximising stock value. Shareholders concernwhether the company is making profit therefore the performance measures theyare interested will be profit related. The most significantadvantage of EVA over non-financial KPIs is it meets the needs of shareholdersmore directly. EVA is able to calculate economic profit by deducting its costof capital from its operating profit.
So the EVA value is the actual wealthcreated for the shareholders. On the other hand, Ittner and Larcker (2000) suggest non-financial KPIssometimes lack verifying links to accounting profits or stock prices and may haveweak statistical reliability that those factors don’t really influence the performance of the firmat all. Sothose figures are not really relevant to shareholders. EVA and KPIs are both good waysto allow managers identify areas to improve.
EVA includes total assets andcurrent liabilities in the calculation, so managers can identify how and wherewealth was created in the company. Managers can look at the balance sheet itemsand focus on areas they can improve or look out for. EVA can also motivatemanagers through compensation schemes because as share price increases,managers’ bonus also increases. Similarly, non-financial KPIs can providequantitative information on company’s intangibleassets such as branding and loyalty.
Therefore, managers can easily compare thenon-financial performance to the industry benchmark and develop strategies tobeat competitors. The major problem of EVA isshort-term orientated. Because EVA is a financial measure, it overemphasises onthe short-term result (Brewer et al 1999).
Therefore, it demotivates managers to invest ininnovative products and technologies. It is because all the investment costswill be recognised in the current accounting period but the benefits orrevenues associated with the investments can only be recognised in the future.This will cause the EVA of the current period low which the manager may bequestioned by the shareholders and lead to layoff. However, non-financial KPIs are long-termorientated, Ittner and Larcker (2000) point out non-financial KPIs can providea closer link to long-term organisational strategies. Improving educationlevel, innovations and customer satisfactions can bring economic benefit in thefuture.
So they also prevent managers to focus on the short-termfinancial measures that it provides a balanced view about the organisationalperformance. Although EVA takes intoaccount of the cost of equity which is neglected in normal accounting. Anotherdisadvantage of EVA is its complex calculations. Abdeem and Haight (2002)suggest it is particularly difficult in the calculation of operating incomeafter tax as it require to convert the GAAP based income to economic income. Itis also difficult to find the correct cost of equity in WACC as there are manyassumptions were made in the capital asset pricing model and it might not besuitable to all kinds of companies.
There are also many adjustments to profitand capital employed figures in order to rectify any possible accountingdistortions of income and investment (Abdeen and Haight 2002). Measuringperformance by KPIs is also difficult, Ittner and Larcker (2000) suggest they can be time consuming as ittakes considerable thought to develop an appropriate scorecard. Alsoimplementing the strategies might involve changing the structure or the cultureof the organisation which may be costly (CIMA 2008, p.8). They do not have acommon denominator andentail different denominators such as time, percentage, quantities.
Therefore,it is difficult for managers to decide how much they need to change or how faroff they are to the target.