ROA, EVA OMG! WTH? And other sundry TLAs

“What gets measured gets managed.” - Peter Drucker 

EBITDA, ROE, ROA, ROIC, EVA—the list goes on.  There are traditional performance measures and value-based performance measures.  Some measures are expressed in monetary terms while others are reflected as a percentage calculation.   There are measures that include the cost of debt and the cost of equity while others include neither.  There are many ways to measure business performance and no lack of opinions on which methodology is the best approach.  Upon analysis, the rabbit hole looks to go deeper than we need to go for our purposes in aligning supply chain performance to financial performance.  If you’re interested in further depth, I’ll include a few resources in the footnotes for further reading.  The balance of this entry will summarize what is found in these resources. 

Most important is to understand how your particular organization calculates financial performance.  There are important distinctions to be understood as an organization develops a common language toward improving customer delivery and achieving corporate business goals.  Again, the foundation for success is a achieving a common language.  Understanding finance as that language and understanding the particular dialect of finance is critical to aligning operations to financial performance.  The metrics determine how decisions are made. 

Return on Assets (ROA)

ROA is a traditional performance measure.  It is a profitability ratio based on absolute numbers.  In practice, ROA is sometimes used by businesses as it is easier to compute and understand and to use in comparison with other companies.

For companies using the ROA approach, it is important to understand that: 

• ROA’s primary focus is on operational profitability and utilization of assets, 
• ROA measures the Return on Investment (ROI) of assets, and 
• ROA can be thought of as an internal facing measure.

Economic Value Added (EVA)

EVA is a value-based performance measure.  It is expressed as a monetary amount.  EVA requires more computations and is a dollar amount.  The currency expression can limit comparisons with other companies.

 

For companies using this approach, it is important to understand that: 

• EVA’s primary focus is on cost of capital and shareholder value, 
• EVA measures the impact assets have on value creation, and 
• EVA can be thought of as an external facing measure.

EVA has an important distinction when compared to ROA.  EVA includes the weighted average cost of capital (WACC).  What does this means to supply chain professionals? ROA as a single metric approach will drive improvements to gross and net profits but will not align to shareholder benefits that are required through improving asset turnover.   The main difference is the way the two models handle assets.  Depreciation as it relates to assets reduces the book value of the assets as they age.   

Ram Sriram from Georgia State University¹ outlines three limitations of using only an ROA approach: 

• Encourages division managers to retain assets beyond their optimal life and not to invest in new assets which would increase the denominator. 
• Can cause corporate managers to over-allocate resources to divisions with older assets because they appear to be relatively more profitable. 
• Capital may be allocated towards least profitable divisions at the expense of the most profitable divisions.

While short-term profitability may be trending in the right direction, lack of longer-term efficiency can erode shareholder value.  There is a limit to raising prices to maintain profit ratios.² Often, there is market demand to lower prices.  In short, it is about using fewer resources to sell more products and services. 

There are entire chapters in books written on the distinctions between these two models.  A single blog entry cannot fully define all the unique characteristics of each model but can simply raise the awareness that distinctions do exist, and as a result create different measures of success.  What gets measured gets managed, and knowing some of the details behind the measure will drive improved alignment between supply chain performance to financial performance.

(1)    “Investments in Assets: Both A Strategic and a Control Issue” Ram Sriram 

(2)    “Measuring the Value of the Supply Chain” Enrico Camerinelli

Additional Resources

• Adding Enterprise Value: Mitigating Investment Decision Risks by Assessing the Economic Value of Supply Chain Initiatives, Oliver Schneider
• Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean, Karen Bergman and Joe Knight
• A Note on the War of Metrics, Gunther Friedl and Tim Kettenring