A great advantage of Balanced Scorecard is the possibility to use it in combination with other performance management systems and individual indicators. We have already written about Six sigma, Total Quality Management, Lean production and the way these systems can work with Balanced Scorecard. This article focuses on EVA (Economic Value Added) and Balanced Scorecard. We will attempt to contrast the two systems to find similarities and differences between them and answer the question whether or not they can be successfully combined.
Economic Value Added – An Individual Indicator
EVA is an estimate of organization economic profits which is calculated in the following way:
- [Net Operation Profit After Taxation] – [Capital Value]
EVA is used to measure efficiency with which organization uses resources. In other words, an economic value added indicator shows difference between return obtained from investments and the cost of resources. Of course, the higher the EVA, the more efficient resource utilization.
- EVA is a registered trade mark by its developer Stern Stewart & Co.
EVA Based Management – Financial Management System
At a first glance, it is not clear how can one compares Balanced Scorecard (which is a system that communicates operational management with strategic goals of the company) with the EVA which is just an individual indicator. The authors of the EVA went further in the development of this concept and created the system called EVA Based Management.
EVA Based Management is a financial management system which offers a solid basis for decision making to key and secondary personnel, as well as makes it possible to make, monitor and measure adopted decisions in a similar “vein” – adding value to shareholders’ investments.
Goals of BSC and EVA
- The goal of BSC is to direct organization to the right track to reach strategic goals and pursue strategic mission.
- The goal of EVA based management is adding value to the company.
The differences between the systems are evident.
- In case of BSC a strategic goal may be just any goal (check out BSC implementation pitfalls), while EVA based management pursues a particular goal of adding value to the company.
However, it would be fair to say that very often companies using BSC include the goal of adding value to the company to the set of strategic goals.
BSC emerged as a result of studies of different methods and tools to evaluate business performance efficiency. The authors of this concept have found out that it is not enough to use only financial indicators to adequately measure organization. That’s why BSC concept includes four perspectives: financial, customer, internal processes, learning and growth.
Balanced Scorecard is based on the following principles:
- Cause and effect relationship
- Interrelationship of indicators which the company can measure in the end of a certain period and indicators which can be evaluated immediately
- Subordination of all indicators financial results
EVA based management emerged as a result of value based management development. EVA indicator became a successor of such indicators as ROI (return on investment) and ROCE (return on capital employed). The following principles lay down the foundation of EVA based management:
- Business owners invest capital to get profits
- The company is founded to get additional profits
- Company personnel aims at increasing shareholders value through a motivation system
EVA based management is based on the indicator mathematical formula. By splitting this formula it is possible to identify objectives and share responsibilities for their implementation.
BSC creators view organization as a strategy-oriented. Most important things to know about Balanced Scorecard:
- Putting strategy into action. BSC makes it possible to transfer strategy to the operational level which makes it possible to aim all actions at implementation of strategic goals.
- Links between organization and strategy. Balanced Scorecard makes it possible to achieve a synergy effect when all departments and business units of a company pursue strategic goals.
- Strategy implementation by all employees. Balanced Scorecard encourages employees to contribute to implementation of strategic goals through an extensive communication and motivation system.
- Real-time strategic management. Balanced Scorecard makes it possible to link budget and strategy with the help of information and analytical systems in order to exercise continuous control and conduct strategic education campaigns.
- Motivation. Balanced Scorecard creates a perfect motivation for employees at all levels.
Creators of EVA based management have established so-called 4 Ms:
- Measurement. EVA based management system makes it possible to create evaluation system for the company which can correctly indicate actual profitability.
- Management system. The system covers a set of managerial decisions, including strategic planning, allocating funds, purchase and sale of actives, goal setting, etc.
- Motivation. A fair compensation and bonus system based on an EVA indicator makes it possible to balance the interests of managers and shareholders.
- Mindset. Implementation of the management and compensation system based on EVA indicator leads to changes in the corporate culture and organization climate.
Drawbacks of BSC and EVA Based Management
Major drawbacks of Balanced Scorecard:
- BSC can be designed only after all employees accept and understand the company strategy
- There is no responsibility for the total results
- This system focuses on managing funds and resources, but not financing them
Key drawbacks of EVA based management system:
- Strong ties between bonuses and EVA indicator may lead to making decisions aimed at short term benefits through cost reduction and use of actives with an expired depreciation term
- Scorecard system consists of financial indicators which ignore such long-term success factors as personnel knowledge, information technologies, corporate culture, etc.
- EVA based management system works more in the short term perspective.
Analysis showed that these management tools are not mutually exclusive. They can be used both separately and in combination. The best effect is achieved through combined usage of EVA and BSC. EVA indicator may be used as a basis of motivation system, as well as a part of financial perspective, while BSC is a major management tool which focuses on implementation of strategic goals and communication between operational in strategic management.