Would you rather have a 20% return on a $100,000 base of invested capital or 10% on $20 billion?
CFOs are capital allocators at heart. Their decisions are measured on multiple scoreboards: as a percentage, as a real dollar amount, and as pure cash flow.
This guide draws on my podcast with Tony Boor, CFO of Blackbaud, a software company that powers nonprofits, charities, and educational institutions. Blackbaud generated over $1.1 billion in revenue last year and is one of the most valuable vertical software companies in the world.
Tony explained that he relies on three metrics to measure the company’s capital efficiency at scale:
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Return on Invested Capital (ROIC)
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Economic Value Added (EVA)
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Residual Cash Earnings
Today, we’ll explore all three metrics and compare their outputs using a real scenario.
“The percentage scoreboard”
ROIC measures how effectively a company uses its invested capital to generate profit. For example, if you invest $1 million and earn $200,000 in profit, your ROIC is 20%. This metric is useful for comparing investment efficiency across different companies or industries.
However, ROIC doesn’t provide insight into the absolute value created, which limits its meaning when considering investments of different scales.
“The P&L scoreboard”
EVA measures the absolute dollar value created over the cost of capital. For instance, if a company generates $150,000 in profit but the cost of capital is $100,000, the EVA is $50,000. It shows whether the company is adding real economic value or destroying it, in absolute terms.
While EVA provides a clear picture of value creation, it’s influenced by the scale of operations, which makes it less comparable across different companies.
“The cash flow scoreboard”
Residual Cash Earnings focuses on the cash generated by the business after accounting for the cost of capital. This metric shows how much cash is available to reinvest, pay off debt, or distribute to shareholders. It reflects the actual cash earnings after covering all capital costs, making it practical for managing working capital and prioritizing resource allocation.
This metric is particularly helpful in understanding liquidity, though it might not capture the full economic profit like EVA, especially when non-cash expenses like depreciation are involved.
To dive deeper into how to calculate these metrics and see full examples of ROIC, EVA, and Residual Cash Earnings, subscribe to access the rest of the guide.