Impact Factor: 5.2 IJAR

  Int ern a tio na l Jo u rna l of Appli ed R esea rch 201 6; 2(2): 365 -3 6 9 ISSN Print: 2394-7500 ISSN Online: 2394-5869 Impact Factor: 5.2 Value based measurement of financial performance IJAR 2016; 2(2): 365-369 www.allresearchjournal.com Received: 17-12-2015 Nader Naghshbandi, Dr. Vineet Chouhan, Dr. Priya Jain Accepted: 20-01-2016 Nader Naghshbandi Abstract Young Researchers and Elite Every company has to be very cautious in selecting their measurement tools, as it will affect Club, Quchan Branch, Islamic substantially the management resources and every department of the company. The concept of Azad University, Quchan- Iran economic framework is an innovative way to measure the value of a company. This economic measurement system determines companies’ worth and performance based on their economic situation Dr. Vineet Chouhan not according to accounting numbers produced using traditional accounting rules. According to the past Assistant Professor, studies, economic frameworks set quality standard in measuring performance and it is necessary for School of Management, Sir Padampat Singhania company to create value for share- holders. Due to ample of evolution in last decade in the corporate University, Bhatewer, world, managers and investors are seeking for an economic framework which better mirror the value Udaipur, Rajasthan-India and profitability of their company. Accounting tools which are being used till today are not sufficient and unlikely in facing the challenge arising from efficient capital markets and owners. Value based Dr. Priya Jain measurement framework, a new economic dimension is required, which could better reflect the Assistant Professor, opportunities and downsides. There are number of value based measurement in the economic frame- Dept. of Accounting, work, for example Economic Value Added (EVA), Cash Value Added (CVA), Cash Flow Return on J. R.N. Rajasthan Vidyapeeth University, Rajasthan, Investments (CFROI), Shareholder Value Analysis (SVA) and Market Value Added (MVA). Any of Udaipur- India. these can be chosen by a company as their economic framework. Value added is a measure of economic performance of an economic entity which has a fairly long history of application in economics. It has been regarded as the increase in wealth of an economic entity. Thus, it is a particular concept of income measurement. A company creates value for its shareholders when the shareholder return exceeds the required return to equity. The shareholder's wealth is measured by the returns they receive on their investment. Economic Value Added (EVA) was introduced and advocated by Stern Stewart and Co. in 1982. This study intended to identify why EVA should be used as financial performance measure over the conventional measures and any added value or added advantage in EVA compare to conventional methods. Today EVA has been able to gain attention of the corporate giants like Coca-Cola, TATA, and Reliance etc. as it is able to depict the true profitability of the company, and however, there have been very little research conducted on EVA in Asian countries including India. Keywords: EVA, Disclosure, Wealth maximization, Performance Measures, MVA 1. Introduction On this earth every task is performed for any purpose whether it is an economic activity or non-economic activity. Business organizations that are related with economic activities especially are also operated for some specific purpose. But due to changes in micro and macro elements of business environment, the main aims of business have also changed. For example, earlier profit maximization was considered the main aim of any business but after sometime this aim has been replaced by the aim of wealth maximization and today this aim has also become unpopular. At present, value generation has taken the place of main aim of all types of business. Now Profit maximization as a concept is age-old, wealth maximization is matured and value maximization is today’s wisdom (Chandra et al, 2012) [3]. In order to operationalise this objective, shareholder wealth is traditionally proxies by either standard accounting magnitudes (such as profits, earnings and cash flows from operations) or financial statement ratios (including earnings per share and the returns on assets, investment Correspondence and equity). This financial statement information is then used by managers, shareholders and Dr. Vineet Chouhan other interested parties to assess current firm performance, and is also used by these same Assistant Professor, stakeholders to predict future performance. Further, under the semi-strong form of the School of Management, Sir Padampat Singhania efficient market hypothesis, the publicly available information contained in these variables is University, Bhatewer, readily interpreted by the market, and thereby incorporated into future stock prices. For Udaipur, Rajasthan-India. years, investors and corporate managers have been seeking a timely and reliable ~ 365 ~  International Journal of Applied Research     measurement of shareholders’ wealth. With such a measure, very much to accounting. But in contrast to the traditional investors could spot over or underpriced stocks, lenders income calculation, one of its major characteristics is that it could gauge the security of their loans and managers could can be and has been used not only in one or two accounting monitor the profitability of their factories, divisions and areas but in all three types of systems: national accounting, firms. financial accounting and managerial accounting. A company creates value for its shareholders when the The General Accounting Plan defines value added as the shareholder return exceeds the required return to equity. The difference between total productions for the period, to which shareholder's wealth is measured by the returns they receive is added the commercial" margin (gross margin) on on their investment. They get returns in two parts, that are merchandise sales, and the consumption of goods and first in the form of dividends and the second in the form of services supplied by third parties for that production capital appreciation reflected in market value of shares of which market value is the dominant part. The market value 4. Review of Literature of share is influenced by number of factors, many, of which, Researches worldwide reveal that may not be fully influenced by the management of firm. Sharma, A.K. & Satish Kumar (2008) [21] in their research However, one factor, which has a significant influence on the paper on, Association of EVA and accounting earnings with market value, is the expectation of the shareholders regarding market value: evidence from India, examined whether the return on their investment. So every organization must Economic Value Added (EVA) can be used as a tool of work for value generation. But only creation of value is not performance measures while investing in Indian market and sufficient for an organization. There should also an effective provide evidence about its superiority as a financial method for the correct calculation of this generated value. performance measure as compared to conventional performance measures in Indian companies. To achieve this, 2. Introduction of Financial Performance Measures performance of the Indian listed manufacturing companies is Traditionally the methods of measurement of corporate compared with traditional mandated corporate financial performance are many. Common bases used are: - Net Profit performance measures used in investment analysis. Further, Margin (NPM), Operating Profit Margin (OPM), Return on the present study ranks the performance Indian companies on Investment (ROI), Return on Net Worth (RONW) etc. Profit the basis of various performance measures and suggests to after Tax (PAT) is an indicator of profit available to the investors which performance measures should be used to shareholder and Profit before Interest after Tax (PBIAT) is analyze the companies in order to make better investment an indicator of the surplus generated using total funds. ROI is decision. The result of this study reveals that investor should still recognized as the most popular yardstick of profitability use EVA along-with traditional measures in firm valuation measurement. and making investment strategy (Chouhan et al, 2013; However, the traditionally used profit indicators are Chouhan et al, 2013 & 2014) [7, 9, 8]. ineffective parameters in explaining whether the reported Erik Stern (2010) in his article on, Why EVA Is the Best profit covers the cost of capital. Old profit concept fails to Measurement Tool for Creating Shareholder Value, indicate clear surplus. The basic proposition is that the presented a comparison between traditional and modern Return on Capital Employed should be greater than the Cost financial performance measures has been made. According of Capital (i.e. ROCE > K0). to it, Economic value added (EVA) has transformed the Capital Employed highlights long term capital and cost of corporate finance scene and business practice by transferring capital represents weighted average cost of capital. modern business theory from classroom to boardroom. Traditionally, Profit after Tax is shown in the Profit & Loss Traditional measures, with their roots in accounting, distort Account to indicate the profit available to the shareholders, economic reality. As they do not consider the cost of capital both preference and equity. Ability to maintain dividend is and unless they take into account the cost of capital, return not a test of profit adequacy. Firm’s profitability and the measures can become inflated. On other hand, EVA is not measurement of such profitability are usually calculated by just a financial metric, but it is a complete management traditional profitability measures such as return on equity system focused on value creation. Bold implementation of (ROE), return on assets (ROA), net farm income (NFI) and EVA signals the beginnings of transparency and the operating profit margin (OPM). accountability, in a firm and implementing EVA half- heartedly or without incentives spells disappointment. 3. EVA as a type of Value Added Joshi, Sanjay Satyanarayan (2011) [17], in his research paper Value added is a measure of economic performance of an on, Relationship Between EVA, MVA and other Accounting economic entity which has a fairly long history of application Measures of Fertilizer Companies in India showed a in economics. It has been regarded as the increase in wealth relationship between EVA, MVA and other accounting of an economic entity. Thus, it is a particular concept of measures of fertilizer companies in India. He examined that income measurement. It has its traditional roots in macro- value creations for shareholders of fertilizer companies in economics, especially regarding the calculation of national India through Economic Value Added and Market Value income which is measured by the productive performance of Added. The objectives of the study are to examine the a national economy and which is called National Product or relationship between EVA, MVA and other accounting Domestic Product. These notions represent the value added measures like Return on Investment (ROI), Return on Equity of a national economy during a specific period. Other than (ROE), Earnings per Share (EPS) and Return on Net worth this common use of the value added concept, it has also been (RONW) through correlation analysis and also ANOVA is discussed and practiced as a useful economic and used to compare the mean value of EVA and MVA for performance indicator in different areas of economics and studied fertilizer companies(Khan et al, 2012) [12]. business administration. The fact that it represents the result Kanthakrishnan, R. and S. Jeyaraj (2011), [20] in their of a calculation means that the value added concept is related research paper on, Enterprising on Eva Excellence - An ~ 366 ~  International Journal of Applied Research     Empirical Study on Select Companies in India, selected few Infrastructure, Machinery, telecommunication, Steel, Cement companies in India with intent to provide an insight into the and Pharmaceuticals based on the significance of the sectors role of Economic Value Added concept as a performance and growth of the companies. Sample companies will be measurement/ management tool in the Indian context. In this drawn by using Convenience Sampling. The study covers the study, it is found that there has been a remarkable turnaround period of five year (2007-2011). Various statistical and other of the Indian corporate sector over the past few years. The techniques such as T test, F test, Chi square test, ANOVA, article focused on the importance of EVA as an improved correlation, regression, balance score card, cash value added, measure of corporate performance over the traditional CFROI etc. has been used. In the present research secondary performance indicators like PAT, ROI, ROCE, EPS, etc. data have been collected from various sources such as annual Worthington, Andrew and West, Tracey (2001) in their paper reports of companies, newspapers, business magazines and on, Economic Value-Added: A Review of the Theoretical journals etc. Besides calculation, for analyzing and drawing and Empirical Literature revealed that with increasing possible correct conclusions from EVA, following variables pressure on firms to deliver shareholder value, there has been have been used as tools in present research- a new emphasis on devising measures of corporate financial  Capital Employed performance and incentive compensation plans that  Weighted Average Cost of Capital encourage managers to increase shareholder wealth. One  Earnings Per Share (EPS) professedly recent innovation in the field of internal and  Return on Average Net worth (ROANW) external performance measurement is a trade-marked variant  Return on Capital Employed (ROCE) of residual income known as economic value-added (EVA).  Return on Total Assets (ROTA) This paper attempts to provide a synoptic survey of EVA’s  Net Operating Profit after Taxes (NOPAT) conceptual underpinnings and the comparatively few  Market Value Added (MVA) empirical analyses of value-added performance measures.  Balance Score Card Special attention is given to the GAAP related accounting  Cash Value Added adjustments involved in EVA-type calculations. Goldberg, S. R. (1999) [11] in his research paper on, Hypothesis of the study Economic value added: A better measure for performance H0= There is no difference in sector-wise disclosure and compensation revealed that Economic value added has practices of financial performance. become increasingly popular as a decision-making tool— H1=There is a significant difference in sector-wise especially for measuring performance and compensation. Is disclosure practices of financial performance. it really better than using traditional measures like earnings per share (EPS) or Return on Equity (ROE). 7. Data Analysis and Interpretation Bardia (2002) [2] in his paper on EVA as performance Disclosure Practices of Sample units Indicator- A Case Study of Infosys wrangled that the concept The above 10 companies were selected for the purpose of the of EVA is better than the concept of accounting profit as a current Study and before comparative study of the above tool a value creation because it considers the overall cost of companies it is required to know their disclosure and types of capital. In this paper an attempt has been made to analyze the disclosure. Hence, it is shown in table 3.1. For the purpose of financial performance of Infosys Technologies Ltd. On the scores of disclosure the category of disclosure was being basis of traditional parameters like ROCE, ROE, EPS, etc. prepared as under: and the new performance measure EVA. Disclosure in Financial records=1 Disclosure in directors report=2 5. Objectives of the study Disclosure in Additional information=3 The objectives of the current research work can be listed as Non-financial disclosure=4 under: For Non-Disclosure=5 1. To analyze the disclosure practices of various value based financial performance measures (Traditional& Short name of companies are as under others) in sample units. Infosys Limited= IL; Bharti Airtel=BA; Cipla Limited=CL; 2. To evaluate EVA as a performance measurement tool in Dr Reddy’s Laboratory.= DRL; HDFC Bank Limited= comparison of traditional methods. HDFC; Dabur Limited= DL; Indian Oil Corporation=IOC, Hindustan Patro Chemicals Limited=HPCL; Oil and Natural 6. Research Methodology used in the research Gas Corporation of India Limited=ONGC; Hero Motor In this research ten companies will be selected as sample Corporation= HM; from different industries like IT, FMCG, Automobile, Table 1: Disclosure scores and points HD HPC ON Disclosure Points IL BA CL DRL DL IOC HM FC L GC Net Operating Profit 3 5 5 3 4 1 2 2 1 1 EPS 1 1 1 1 3 1 1 1 1 1 ROANW 3 5 5 3 2 3 3 5 3 2 ROCE 3 5 5 3 2 3 1 3 2 3 ROTA 3 5 5 3 3 3 5 1 2 3 ROI 3 5 5 1 2 3 5 5 3 3 liquidity ratio 3 5 5 3 5 3 5 5 3 3 Invested Capital 1 1 1 1 1 1 1 1 1 1 Firm Size 3 1 3 3 2 2 3 1 2 3 ~ 367 ~  International Journal of Applied Research     Continue Table Cost of Equity 3 5 5 3 5 5 5 5 5 3 BETA 3 5 5 5 5 5 5 5 5 3 listing Status 4 1 4 4 1 1 2 3 3 3 Share Prices 1 3 2 3 3 3 3 3 3 3 Ratio of Debt to Total Equity 3 5 5 3 5 5 3 2 5 5 WACC 3 5 5 3 5 5 5 5 5 3 EVA 3 5 5 3 5 5 5 5 5 3 MVA (Market Capitalization) 3 5 3 3 5 3 5 3 3 3 CVA 5 5 5 5 5 5 3 3 5 5 BSC 5 5 5 5 5 5 5 5 5 5 Disclosure of various items by companies To analyze the intercompany difference between disclosure Table-1 shows the disclosure of the various items and the the following hypothesis were developed: place of disclosure of those items. Further to analyze the H0= No significant difference exists between companies for disclosure statistically there are three important points to be disclosing the selected disclosure points considered; whether all the items required for disclosure are H1= A significant difference exists between companies for disclosed by all the companies? (Or there is any inter- disclosing the selected disclosure points company difference) Whether all the items are being To test the above hypothesis the one sample t test is being disclosed by the companies at the same place? (Or difference used. The result of one sample t test is being shown under in place of disclosure) And whether disclosure of selected table 2. disclosure points by all the companies remains equal in all the companies? (Or there is an item wise difference) Table 2: One-Sample Test 95% Confidence Interval of the Difference Companies t df Sig. (2-tailed) Mean Difference Lower Upper IL 11.909 18 .000 2.9474 2.427 3.467 BA 10.500 18 .000 4.0526 3.242 4.864 CL 12.723 18 .000 4.1579 3.471 4.844 DRL 11.303 18 .000 3.0526 2.485 3.620 HD FC 10.137 18 .000 3.5789 2.837 4.321 DL 9.130 18 .000 3.2632 2.512 4.014 IOC 9.750 18 .000 3.5263 2.766 4.286 HP CL 8.841 18 .000 3.3158 2.528 4.104 ON GC 9.347 18 .000 3.2632 2.530 3.997 HM 10.913 18 .000 2.9474 2.380 3.515 Table 2 revealed that there is a significant difference H0= Disclosure of selected disclosure points by all the (p=.000< 0.5) in the disclosure of various disclosure points companies remains same in all the companies. among all the companies. H1= a significant difference exists in the Disclosure of To further elaborate the differences of disclosure among the selected disclosure points between all the companies. disclosure of the various disclosure points following To analyze the above hypothesis one way ‘t’ test were being hypothesis were developed: conducted. The result of one way ‘t’ test were shown in table 4. Table 4: One-Sample Test 95% Confidence Interval of the Std. Sig. Mean Disclosure item N Mean t df Difference Deviation (2-tailed) Difference Lower Upper Net Operating Profit 10 2.9000 1.51831 5.596 9 .000 1.90000 1.1894 2.6106 EPS 10 1.2000 .61559 1.453 9 .163 .20000 -.0881 .4881 ROANW 10 3.8000 1.19649 10.466 9 .000 2.80000 2.2400 3.3600 ROCE 10 3.4500 1.27630 8.585 9 .000 2.45000 1.8527 3.0473 ROTA 10 3.3500 1.42441 7.378 9 .000 2.35000 1.6834 3.0166 ROI 10 3.7500 1.25132 9.828 9 .000 2.75000 2.1644 3.3356 liquidity ratio 10 4.2000 1.19649 11.961 9 .000 3.20000 2.6400 3.7600 Firm Size 10 2.8000 1.05631 7.621 9 .000 1.80000 1.3056 2.2944 Cost of Equity 10 4.4500 .99868 15.449 9 .000 3.45000 2.9826 3.9174 BETA 10 4.7000 .73270 22.584 9 .000 3.70000 3.3571 4.0429 listing Status 10 2.7000 1.38031 5.508 9 .000 1.70000 1.0540 2.3460 Share Prices 10 2.7500 .63867 12.254 9 .000 1.75000 1.4511 2.0489 Ratio of Debt to Total Equity 10 4.4500 .99868 15.449 9 .000 3.45000 2.9826 3.9174 WACC 10 4.5000 .88852 17.616 9 .000 3.50000 3.0842 3.9158 EVA 10 4.4000 .94032 16.170 9 .000 3.40000 2.9599 3.8401 MVA (Market Cap) 10 3.9500 1.14593 11.513 9 .000 2.95000 2.4137 3.4863 CVA 10 4.8000 .61559 27.606 9 .000 3.80000 3.5119 4.0881 ~ 368 ~  International Journal of Applied Research     Table 4 revealed that a significant difference exists in the Business and Enterprise Applications (IJEBEA), 2013; Disclosure of selected disclosure points between all the 5(1):95-99. companies (p=0.05>significant value), but in case of 10. Erik Stern Why EVA Is the Best Measurement Tool for disclosure of only on item i.e., EPS the disclosure remains Creating Shareholder Value, 2010. same in all the companies as t=1.453, P=0.163>0.05. http://www.qfinance.com/business-strategy-best- Hence we can conclude that despite of various Accounting practice/why-eva-is-the-best-measurement-tool-for- standards there is a huge difference in disclosing the selected creating-shareholder-value?page=1 items by the selected companies which represent the Indian 11. Goldberg SR. Economic value added: A better measure market and part of BSE and NSE. Thus accounting experts for performance and compensation? J. Corp. Acct. Fin., and CA’s have to think about the disclosure of non-financial 1999; 11:55-67. items in the 12. Khan S, Chouhan V, Chandra B, Goswami S. Measurement of Value Creation Vis-à-Vis EVA: 8. 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