The Leading Business Education Network for Doctors, Financial Advisors and Health Industry Consultants

Understanding MEVA?

www.HealthcareFinancials.com

It is not unusual for a medial practice to incur extra-ordinary expenses by investing in technology or equipment. But, did you know that there are two methods of evaluating these capital expenses?  

·   The older Generally Accepted Accounting Principles (GAAP) removes them from the income statement that is used to evaluate enterprise profitability.

 ·  The newer Economic Value Added (EVA) approach treats them differently by considering both capital expenses and operational expenses when calculating profit.  

Introduction 

The concept of EVA was developed by New York City-based consultancy Stern Stewart. MEAV is a riff off this distinction applied to medical practice capital investments by distinguishing between illusory profits and real economic gain.  

The concept is useful to keep physician executives from disrupting the balance sheet by chasing profits. It may also better reflect enterprise value since to have a positive MEVA – practice revenues must exceed operating costs, taxes and a charge for the cost of capital (debt interest rate charges, or the risk of saving/conserving capital rather than spending/investing it).

In other words, the benefits of major equipment must be weighed against the financial drain of purchase. Additionally, taxes are also left out of a GAAP analysis of operating profit, but MEVA expensing includes them to keep operations as lean as possible.

Nevertheless, the MEVA formula may be expressed, as follows: MEVA = NOPAT – (Cost of Capital X Capital)orMEVA = (Operating Profit) – (A Capital Charge) where: NOPAT = (Taxable Income – Income Tax)where: Cost of Capital X Capital) = Depreciation X (Beginning Book Value).

As seen in the MEVA equations, there are two key components.  The net operating profit after tax (NOPAT) and the capital charge, which is the amount of capital times the cost of capital. 

NOPAT is the profit derived from operations after taxes, but before financing costs and non-cash bookkeeping entries. 

In other words, it is the total pool of profits available to provide cash return to the physician executives who provided capital to the practice.  The cost of capital is the minimum rate of return on capital required to compensate physician debt and equity owners for bearing risk – a cut-off rate to create value. 

On the other hand, capital is the amount of cash invested in the practice, net of depreciation.   

Criticism of MEVA Calculations 

It is important to note that the above only represents one of the many ways to define MEVA.  In reality, the definition of MEVA should be tailored to the specifics of the practice that uses it.

Also, in reality, there are adjustments that may change the way a practice defines MEVA. These equity equivalent (EE) adjustments are used to both NOPAT, and the capital employed, to reduce non-economic accounting and financing conventions on the income statement and balance sheet.  Equity equivalents (EEs) are adjustments that turn a practice’s accounting book value into an economic book value, which is more accurate measure of the cash that physician owners have put at risk and upon which they expect to accrue some returns.  

Equity equivalents turn capital-related items into more accurate measures of capital and include revenue-and expense-related items in NOPAT, thus better reflecting the practice’s base upon which owners expect to accrue their returns.

Furthermore, equity equivalents are designed to address the distortions suffered by traditional financial ratio measures, that change depending upon the generally accepted accounting principles adopted or the mix of financing employed. 

Moreover, the basic formula for MEVA tends to produces a more conservative picture of ROI, and medical practice profits or losses. 

Summary 

Therefore, MEVA should not be used too rigorously for fear of excessive risk aversion and the paralysis of analysis. Your experience with this concept is appreciated. 

Channel Surfing

Have you visited our other topic channels? Established to facilitate idea exchange and link our community together, the value of these topics is dependent upon your input. Please take a minute to visit. And, to prevent that annoying spam, we ask that you register. 

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com 

Get our Widget: Get this widget!

Our Other Print Books and Related Information Sources:

Practice Management: http://www.springerpub.com/prod.aspx?prod_id=23759

Physician Financial Planning: http://www.jbpub.com/catalog/0763745790

Medical Risk Management: http://www.jbpub.com/catalog/9780763733421

Healthcare Organizations: www.HealthcareFinancials.com

Health Administration Terms: www.HealthDictionarySeries.com

Physician Advisors: www.CertifiedMedicalPlanner.com

Subscribe Now: Did you like this Medical Executive-Post, or find it helpful, interesting and informative? Want to get the latest ME-Ps delivered to your email box each morning? Just subscribe using the link below. You can unsubscribe at any time. Security is assured.

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Sponsors Welcomed

And, credible sponsors and like-minded advertisers are always welcomed.

Link: https://healthcarefinancials.wordpress.com/2007/11/11/advertise

Filed under: Accounting | Tagged: Financial Markets |