Financial performance measures and value creation: a review

Corporate financial performance measured in terms of accounting-based ratios has been viewed as inadequate as firms began focusing on shareholder value as the primary long-term objective of the organization. Corporate managers have been facing a period where a new economic framework that better reflects economic value and profitability had to be implemented in their companies. The increased efficiency at the capital markets requires that capital allocation within companies become more efficient: a value based management framework that better reflects opportunities and pitfalls, is therefore necessary. Subsequently, value metrics were devised that explicitly acknowledged that both equity and debt have costs, and thus there was a need to incorporate financing risk-return into performance calculations. The focus of this article is a review of the main value-based measures: the economic value added (EVA), the cash flow return on investment (CFROI) and the shareholder value added (SVA). The objective is contributing to the developing dialogue on the appropriateness of different financial performance measures by reviewing their differences as well as their similarities in terms of measurement, association with market financial performance and DCF approach, implications on managerial incentives, and by highlighting their respective strengths and weaknesses.