Cash Value Added (CVA) is an enterprise profitability measure defined as the enterprise-generated EBITDA, less tax, less its expected return. CVA may be a somewhat esoteric metric developed by the research firm Boston Consulting Group, which measures a company’s ability to get income above and beyond its cost of capital. The required return is an annuity based on the purchase price of the assets being used in the business, inflated with the value of money today, the weighted average cost of capital (WACC), and the assets’ economic life.
In general, a high CVA signifies the capacity of a company to produce net income from one financial cycle to the next. There is an absolute sum of residual. The CVA is determined by subtracting the cost of capital employed expressed as a minimum cash flow required from the cash flow generated in a year. This can also be represented as an index, where the necessary return divides the CVA. The CVA is positive and value is generated when the particular income is above the minimum income required to hide the value of capital employed. An index of quite 1.0 will indicate profitability while an index below 1.0 will indicate value destruction.
The Boston Consulting Group designed the following two CVA calculation methods:
Direct: CVA = gross cash flow – economic depreciation – capital charge
Indirect: CVA = (CFROI – cost of capital) x gross investment
CFROI is cash flow return on investment, or ((gross cash flow – economic depreciation) / gross investment)
Economic depreciation is (WACC / (1+WACC)^n -1)
Gross cash flow is adjusted profit + interest expense + depreciation
The capital charge is the cost of capital x gross investment
Gross investment is net current assets + historical initial cost
In reality, CVA gives investors an idea of the capacity of the company to produce cash from one fiscal cycle to another. The minimum cash flow needed is the amount of the needed return on capital hired, a rate of capital recovery, and the flat rate of taxation. CVA focuses primarily on the cash flow of a business while the EVA focuses on the overall valuation of a company. Capital returns are measured using the weighted average capital cost (WACC) which includes both debt and equity.