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Are you managing profits and working capital separately?
Most companies track and manage profits, as well as working capital usage. Both are important. The objective is to maximize profits and minimize usage of working capital.
In such a scenario, how do we evaluate opportunities which improve profits but involve higher working capital? The decision policies are often vague and result in incorrect evaluation of such opportunities. We have seen cases where some significant opportunities get shelved due to this confusion.
Economic Value Added (EVA) is one such metric which combines profits, investment and working capital into a single measure. An increase in profits results in higher EVA. Higher usage of working capital reduces EVA through the concept of capital charge.
We can now compute the net impact on EVA for an opportunity which increases profits but involves higher working capital usage.
A decision policy to improve EVA removes confusion and leads to clear decisions by the operating people.