What is the Difference Between Residual Income and EVA?

Residual Income and Economic Value Added (EVA) are both methods used to evaluate investment opportunities and assess the excess funds generated by an investment over its cost of capital. However, there are some differences between the two concepts:

1. Calculation: Residual Income calculates the amount of asset utilization based on Net Operating Profit, while EVA calculates the amount of asset utilization based on Net Operating Profit After Tax.
2. Tax Adjustments: Residual Income does not account for tax adjustments, whereas EVA takes into consideration tax adjustments.
3. Formula: The formula for Residual Income is Net Operating Profit - (Operating Assets * Cost of Capital), while the formula for EVA is Net Operating Profit After Tax - (Operating Assets * Cost of Capital).
4. Effectiveness: Residual Income is considered more effective compared to EVA because it does not adjust for taxes, which can lead to different interpretations of asset utilization and investment returns.

Both methods are based on the same principle, i.e., to identify how effectively a company utilized its assets, but they differ in the way they are calculated and in their effectiveness.

Comparative Table: Residual Income vs EVA

Residual Income and Economic Value Added (EVA) are both performance measurement methods used to evaluate a company's or division's performance. Here is a table summarizing the key differences between the two:

Both residual income and EVA are based on the same principle, but they differ in the way they calculate the finance charge and the basis of their calculations. Residual income uses operating profit, while EVA uses net operating profit after tax. Additionally, residual income uses a finance charge derived by multiplying the capital by the cost of capital, whereas EVA uses the weighted average cost of capital (WACC) to calculate the finance charge.