Until a business returns a profit that is greater than its cost of capital, it does not create wealth, it destroys it.
Measuring total-factor productivity is one of the major challenges confronting the executive in the age of knowledge work. For manual work, measuring quantity is usually sufficient. In knowledge work, we have to manage both quantity and quality, and we do not know yet how to do that. We must try to assess total-factor productivity using the common denominator of revenues and expenses. By measuring the value added over all costs, including the cost of capital, EVA (economic value added analysis) measures, in effect, the productivity of all factors of production [or the true economic costs produced by all resources used].
Never mind that a business pays taxes as if it had earned a profit. It does not cover its full costs until reported profits exceed its cost of capital. Until a business returns profit that is greater than its cost of capital, it operates at a loss. And this is why EVA is growing in popularity. It does not, by itself, tell us why a certain product or a certain service does not add value or what to do about it. It does show which products, services, operations, or activities have unusually high productivity and add unusually high value. Then we should ask ourselves, “What can we learn from these successes?”
ACTION POINT: Calculate the “economic value added” for your organization or for a product or service that you provide.
Management Challenges for the 21st Century
From Data to Information Literacy (Corpedia Online Program)
* Source: The Daily Drucker by Peter F. Drucker