The concept of economic profit (EVA) has proved successful in the field of corporate finance since its adoption by several U.S. and International companies over the past 25 years. Unlike accounting earnings, EVA is a measure of a company’s true earnings because it fully “accounts” for the costs of all forms of financing, including debt and equity. In the EVA view, a company is not truly profitable unless it earns a return on capital that bests the opportunity cost of capital. That being said, the question that we address here is how to measure the economic profit of providers in the healthcare sector, which is largely comprised of Not-for-Profit organizations such as clinics, laboratories, and hospitals.
We’ll begin the EVA journey for healthcare providers by abstracting from the myriad of accounting adjustments that can be made to estimate EVA and instead look at how to estimate “basic” economic profit in both For Profit (the traditional realm for EVA application) and Not-for-Profit settings. The financial goal here is twofold: (1) to illustrate the key ingredients of economic profit for healthcare providers without getting tangled up in a web of accounting adjustments and, (2) to illustrate the advantage of using economic profit over traditional accounting profit measures such as operating margins and net income.
Grant, James, "A Primer on EVA for Healthcare Providers" (2006). Financial Services Forum Publications. Paper 18.