Pro Tip #8: Use Economic Value Added (EVA) & EVA Margin to Evaluate Farm Enterprises & the Business as a Whole
The vast majority of agriculture businesses are monocultures with one product. Regenerative agriculture business models stack multiple enterprises on the same resource base. This requires much more sophisticated financial analysis at both the startup decision making stage picking which enterprises to pursue and the ongoing management of multiple enterprises. The net result is that most regenerative agriculture ventures ultimately end up looking more like a conglomerate with multiple business lines or divisions than a traditional farm enterprise with a single product (or product class).
Allan Savory incorporated Gross Margin Analysis into Holistic Management for this application to evaluate individual enterprises:
Gross Margin = Revenues – Operating Costs
This is calculated at the enterprise level and ignores corporate overhead and treats all past investments and capital as sunk costs. This was state of the art at the time Savory developed Holistic Management. The fatal flaw of Gross Margin Analysis is that it ignores capital costs and capital. This has resulted in way too many farms with essentially 1% to negative returns on capital.
Fortunately, there is a better approach, Economic Value Added (EVA), that was developed by Bennett Stewart and Joel Stern at Stern Stewart (a very high-end corporate strategy consulting firm) in the late 1980s. EVA is calculated as follows:
Economic Value Added = Revenues – Operating Costs – [Weighted Average Cost of Capital * Total Capital]
Note that there are three sets of adjustments:
- Leases are added back to the capital base as the present value of the remaining obligation.
- Advertising, R&D expenses, new product development expenses, and employee training expenses are removed from operating expenses and are capitalized over five years instead of being expensed the year the cash is spent.
- Restructuring expenses are treated as capital investment.
EVA consistently measures value creation. You want to maximize EVA. This measure works at both the business as a whole and at individual operating units.
EVA Margin is a second measure that is valuable:
EVA Margin = EVA / Total Revenues
Note that for most companies, EVA Margin is in the single digits with about half having EVA margins below 1%.
For corporate cashflow model purposes, we calculate both EVA and EVA Margin at the enterprise level and at the business as a whole level. Note that the enterprise level calculation replicates Gross Margin Analysis and only include the revenues, operating costs, and capital base directly associated with the enterprise. This gives an accurate evaluation of multiple potential enterprises and can be very useful in determining which ones to enter as well as helping prioritize the order in which one enters into new enterprises – you want to prioritize the enterprise with the highest EVA and allocate capital to the set of enterprises that maximizes total EVA.
Note that some “enterprises” may be marginal as stand-alone enterprises but are worth doing for ecological purposes even though they operate at a loss or have marginal EVA. Examples include honey bees if you have an orchard, fish in an aquaponics system, and cover crops used for soil building. In these cases, the marginal “supporting” enterprise should be evaluated as a maintenance cost for the main enterprise (e.g. the greenhouse or the orchard) and not as a stand-alone enterprise.