ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

CASE STUDY - Intergrated ABC & EVA Approach

Updated on December 17, 2010

This Hub is a continuation of my previous two Hubs: (1) ABC and (2) EVA. In this Hub, ABC & EVA would be combined. As would be observed later in the report, this integrated approach outsmarts both TCA and ABC. The integrated approach is more reliable as it traces the use of capital to different products which, in turn, enables the management in better decision-making and strategic planning.

ABC is a valuation system which assigns values to different production on the basis of direct benefits obtained by them from resources of the enterprise. It results in improved operating efficiency. On the other hand, EVA is a financial performance indicator and is helpful in improving financial efficiency. A combined approach would enable the managers to take into consideration all costs, manufacturing and non-manufacturing, relating to their products, jobs or services.

There are ample examples of companies showing excellent operating profits but ending in huge losses due to heavy payments of interest and penal interest.

 

Financial statements of the company are given as per Table 1 & 2.

Table 1

Table 2

As explained in the Hub on EVA, some adjustments were made in profit, total capital invested. Similarly, Weighted Average Cost of Capital (WACC) was calculated. On the basis of these working, EVA was arrived at as follows:

  • Net Operating Profit After Tax . Rs.1,028,160
  • Less Cost of Capital … … … … .Rs.1,302,272
  • EVA … … … … … … … … … … .Rs. (274,112)

Once we know, there is an economic loss, we would try to find out which product caused this loss. Apportioning costs arbitrarily would punish the “bread-winners” and would hide the parasites.

 

Just like in ABC, while computing EVA for each product, we need to find how the financial cost would be distributed among the products. This is uphill task and involves a number of techniques like:

  • CAUSE & EFFECT RELATIONSHIP – Funds of a business are tied up in inventories and Trade Receivables. Mark up on working capital loans can be distributed through analyzing purchase account, finished goods stock position and trade receivable. If a particular product is strictly sold against cash, it should not be loaded with trade finance.
  • DIRECT TRACING – if a bank loan was raised for a particular product it can be allocated to it.
  • TIME & MOTION STUDIES – Fixed Assets are financed through Debt & Equity. Naturally, some markup and dividend expectations are linked with fixed assets acquisition. Through time and motion study, it can be ascertained as to which product has taken how much time in the process. Finally, a rough estimate can be made for allocation of financial costs on the basis of fixed assets usage by different products.

Based on the foregoing, the Cost of Capital of Rs.1,302,272 was apportioned between the two products as shown below:

  • Table 3 – Working Capital and Fixed Assets Costs were studied and allocated to two products in %ages.
  • Table 4 – Actual balance under working capital and fixed cost were split on the basis of percentage arrived at Table-4. This was necessary to calculate weighted %Total
  • Finally, the total Cost of Capital was apportioned for the purpose of calculating EVA as shown in Table 5.

Table 3

Table 4

Tabl 5

Economic Value Added (EVA)

CONCLUSION:

Under TCA, Large Parts were rated very high as they appeared to contribute 85% of profits. Under ABC, this percentage slides down to 69% or down by 16%. Worst was still to come when EVA disclosed that the Large Parts were making extensive use of capital. When incorporated to our financial model, it became evident that Large Parts are causing havoc and the enterprise is sustaining on the contribution made by the Small Parts which were originally belittled due to distortion in financial information.

If there is a reward system, all those engaged in small part operations should be rewarded and those in the large part section should be asked to look for way and means to cut costs and also review their product costing and pricing policies.

Comments

    0 of 8192 characters used
    Post Comment

    • profile image

      yaseen huo 

      7 years ago

      Suppose you have invested Rs.2,500,000 in a house. It rental after 40% tax is Rs.432,000 per annum. If you divide it by 15% ( average market return), the market value of your house would be Rs.2,880,000 or MVA of Rs.380,000.

      If you calculate MVA, it would be 17.28% (432,000 divided by 2,500,000) minus 15% multiplied by 2,500,000 = 57,000. If you just divide 57,000 by 15%, you get the same Rs.380,000.

      Please do not hesitate to ask for any clarification

      hafeezrm 20 months ago

      Sorry,change second last para as: If you calculate EVA, it would be ......

      mashood_khan 19 months ago

      Thank you Very Much Mr. Hafeez:

      Very well explained with a sound example, I have no ambiguity now and got the concept clearly.

      Mubin Ashraf 18 months ago

      Its an easiest way to gain something. Atleast I can recall things well.

      Sreenidhi 4 days ago

      Dear Sir, I am an MBA student want to do my project on analysis of EVA for 100 crore company... what are the initial steps i should take..

      hafeezrm 4 days ago

      Dear Sreenidhi

      Thanks for your email. You obtain annual accounts of a company and follow the guidelines given by me and in other literature.Suppose you have invested Rs.2,500,000 in a house. It rental after 40% tax is Rs.432,000 per annum. If you divide it by 15% ( average market return), the market value of your house would be Rs.2,880,000 or MVA of Rs.380,000.

      If you calculate MVA, it would be 17.28% (432,000 divided by 2,500,000) minus 15% multiplied by 2,500,000 = 57,000. If you just divide 57,000 by 15%, you get the same Rs.380,000.

      Please do not hesitate to ask for any clarification

      hafeezrm 20 months ago

      Sorry,change second last para as: If you calculate EVA, it would be ......

      mashood_khan 19 months ago

      Thank you Very Much Mr. Hafeez:

      Very well explained with a sound example, I have no ambiguity now and got the concept clearly.

      Mubin Ashraf 18 months ago

      Its an easiest way to gain something. Atleast I can recall things well.

      Sreenidhi 4 days ago

      Dear Sir, I am an MBA student want to do my project on analysis of EVA for 100 crore company... what are the initial steps i should take..

      hafeezrm 4 days ago

      Dear Sreenidhi

      Thanks for your email. You obtain annual accounts of a company and follow the guidelines given by me and in other literature.

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      7 years ago from Pakistan

      Dear Sreenidhi

      Thanks for your email. You obtain annual accounts of a company and follow the guidelines given by me and in other literature.

    • profile image

      Sreenidhi 

      7 years ago

      Dear Sir, I am an MBA student want to do my project on analysis of EVA for 100 crore company... what are the initial steps i should take..

    • profile image

      Mubin Ashraf 

      9 years ago

      Its an easiest way to gain something. Atleast I can recall things well.

    • mashood_khan profile image

      mashood_khan 

      9 years ago

      Thank you Very Much Mr. Hafeez:

      Very well explained with a sound example, I have no ambiguity now and got the concept clearly.

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      9 years ago from Pakistan

      Sorry,change second last para as: If you calculate EVA, it would be ......

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      9 years ago from Pakistan

      Dear Mashood,

      MVA is a broader term calculated as: MVA = Total Market Value minus Capital Invested.  On the other hand, EVA is for a particular year: EVA = %Return - % Cost of Fund multiplied by Invested Capital. We can say that MVA = EVA divided by Cost of Funds. Or MVA = PV of all EVA.

      Suppose you have invested Rs.2,500,000 in a house. It rental after 40% tax is Rs.432,000 per annum. If you divide it by 15% ( average market return), the market value of your house would be Rs.2,880,000 or MVA of Rs.380,000.

      If you calculate MVA, it would be 17.28% (432,000 divided by 2,500,000) minus 15% multiplied by 2,500,000 = 57,000. If you just divide 57,000 by 15%, you get the same Rs.380,000.

      Please do not hesitate to ask for any clarification

    • mashood_khan profile image

      mashood_khan 

      9 years ago

      Dear Sir:

      Can you please clarify me the difference between Economic Value Added and Market Value Added?

    • sophiewf profile image

      sophiewf 

      9 years ago from US

      I love your tips.

    • hafeezrm profile imageAUTHOR

      hafeezrm 

      9 years ago from Pakistan

      Dear Usman. You are welcomed to ask for any clarification.

    • profile image

      Usman Ali Siddiqui 

      9 years ago

      Dear Sir,

      I have read some of your studies. These are really good, infact I was looking forward to revise some of exercises of finance and project management. I guess these studies of yours will be a great help towards my revision sir.

      Usman

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://hubpages.com/privacy-policy#gdpr

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)