COP26 has shone a spotlight on the concept of a circular economy. While the shift away from a linear model will have profound – and necessary – impacts on physical supply chains, there will also be inevitable consequences in terms of P&L and the balance sheet.
After analysing the basic aspects of the circular economy in a previous TMI article, and the differences with the linear model, we will now analyse the impacts of the circular economy on the company’s strategic financial components through the economic value added (EVA) model, an important performance indicator calculated as the difference between the net operating income (difference between revenues and costs of production) and the cost of capital used to produce that income (weighted average cost of capital, WACC). It is useful for understanding whether a company is producing value (EVA>0) or destroying value (EVA<0) against certain investments and business practices.
This model emphasises asset turnover (total revenues ÷ total assets), that measures the company’s ability to improve productivity with a reduced use of resources and that is useful to determine shareholders’ value.
The EVA model examines the profit and loss statement (P&L being sales and revenues, cost of goods sold, taxation) and the balance sheet of the company (WACC, being inventory expenses, accounts payable, accounts receivable); they will be analysed individually to assess their advantages and concerns.
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