Economic Profit

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Also known as: Economic Value Added (EVA), Economic Value Added, EVA

Economic profit is the profit a business earns after deducting a charge for all the capital it uses, both debt and equity, showing whether it earns more than the full cost of its capital.

Accounting profit deducts interest on debt but makes no charge for shareholders' money. Economic profit corrects this by subtracting a capital charge, equal to the capital invested multiplied by the weighted average cost of capital, from after-tax operating profit.

For example, a company has net operating profit after tax of 30,000,000 and invested capital of 200,000,000, with a cost of capital of 9%. The capital charge is 18,000,000, so economic profit is 12,000,000. The company is creating value. If its operating profit were only 15,000,000, it would have an economic loss of 3,000,000, despite being profitable in accounting terms.

Economic profit links performance directly to value creation, and is used for strategy, performance measurement and executive pay. Economic value added (EVA), a trademarked version developed by the consulting firm Stern Stewart, adds a set of specific accounting adjustments.

Calculating economic profit requires estimates of invested capital and the cost of capital, so results depend on the assumptions used.

Note: Economic value added (EVA) is a branded version of economic profit with specific accounting adjustments.

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