We all know that Six Sigma can have positive financial effects when used to improve company processes. Not only can it help reduce inefficiency to counteract falling productivity, but Six Sigma can also help you increase your revenue. A useful concept in Six Sigma is that of Economic Value Added (EVA). Using Six Sigma, you can actively create Economic Value Added to increase the intrinsic worth of your business. Today we look at how you can create Economic Added Value using Six Sigma tools and techniques.
How Six Sigma Can Help Improve Projects for Greater EVA
Six Sigma is, of course, a methodology for process improvement. By focusing on and eliminating variation, you can streamline processes to improve quality. This subsequent increase in quality also has a trickle-down or domino effect throughout the rest of the business. But remember, it’s always best to improve a range of areas and not just a single process. Then you’ll be more likely to see the benefit of Six Sigma. When working on process or quality improvement projects, you can use Six Sigma techniques like DMAIC and root cause analysis to solve problems. You will find yourself reducing variation and increasing productivity, to name a few benefits.
These positive outcomes will make your company a more bankable investment opportunity for potential shareholders, and increase current shareholders’ confidence in you. Therefore, using Six Sigma, it’s possible to create greater Economic Value Added for your company. This will improve your standing for shareholders and increase the intrinsic value of your company.
Calculating Economic Value Added
Economic Value Added is a strong measure of the surplus value generated via investment. Stern Stewart & Company created the formula as a way of compiling yearly performance rankings for publicly-owned corporations. But EVA can also be used for private businesses to glean a greater understanding of the inherent worth of their company compared to others. It’s also surprisingly simple to calculate.
First, we look at the present value of all the free cash you expect to flow into the company in the future. If your capital is $100 million per year, including any debts or shareholders’ equity, EVA allows you to calculate the usage costs. You may use capital for various activities, such as paying interest, the cost of which, at $100 million, would be $10 million per year. With this figure in mind, you can increase economic value for your business’s shareholders. This only applies, however, when your projects bring in $10 million plus per year.
To calculate Economic Value Added, you must use the following equation:
EVA = OPBT – T – (TCE X WACC).
- OPBT (Operation Profit Before Tax)
- T (Tax)
- TCE (Total Capital Employed)
- WACC (Weighted Average Cost of Capital)
We find that EVA is highly beneficial as it makes it clear when your company is doing well, plus when it isn’t. Large businesses especially can become so caught up in generating profit, that they neglect the associated costs.
Applying Economic Valued Added with Six Sigma
Both EVA and Six Sigma rely on strong data to be able to function. Using Six Sigma tools, you can create an ideal work environment that generates profit through streamlined and variation-free processes. This will hold you in good stead when it comes to creating greater EVA. You can apply EVA to several business areas, including target-setting, managerial bonus allocation, investor communication, and acquisition/merger valuation. You can even use Six Sigma to eliminate operating expense, which will help to further improve EVA.