Return on Investment and Economic Value Added as Performance measures in an Organisation. Introduction
Performance measurement in an organisation is a fundamental requirement by management, investors and other stakeholders. This ultimately guides stakeholders to make appropriate decisions based on information available to them to determine what the organisation wants to achieve and how the performance will be measured. Organisations that are large in structure and operations focus has been to ensure shareholders wealth are maximised which means management, investors and other stakeholders require to know the performance of the organisation as this will aid them to make appropriate. We will consider the measures put in place both financial and non financial that will enable handlers of organisation to have a good evaluation of the performance of the business. 1
According to Tudor Spencer (2005) who stated that
‘‘No two organisations are financially managed in an identical way. This is because different organisations have different purpose, operate in different environments, have different histories or just managed by unique personalities with different preferences’’ (Tudor Spencer 2005; pg 130). Large organisations are grouped into divisional and non-divisional organisational structures. In divisionalized organisation the structure causes a decentralization of decision making process as the central head office creates different divisions managed by divisional managers. This is the opposite in non divisional organisation as responsibility for profit lies with the central head office. The divisional manages are given autonomy to determine profit responsibility which falls into an investment, profit or cost centre. Investment centre
Investment centres are basically decentralised divisions that a manager of an organisation has control and maximum discretion. The manager will determine the level and type of capital investment decision the division will handle, operating decision on product mix, pricing and various production methods for the division. Profit centre
Profit centres are divisions that the managers do not have control over investments decision making process in the division. The manager responsibility is to ensure that profit is generated from operations on the assets from the head office which the division reports to directly.
Cost centres are divisions where the managers are only responsible for cost but not profit. 1.1
Divisional Performance measurement
Performance evaluation of divisions can be considered in two aspects; -
Return on Investment (ROI)
Economic Value Added (EVA™)
1.12 Return on Investment (ROI)
The return on investment (ROI) is a performance measurement mostly used for an investment centre. It is expresses divisional profit as a percentage of the assets employed in the operations of the division. ROI = Net income/Invested capital
ROI = [Net income X Sales (Revenue) ]/[Sales (Revenue) X Invested capital] ROI= Net profit ratio x Capital turnover
The intent of this measure is to evaluate the success of an organization or division by comparing its operating income to its invested capital. The ROI is generally an objective measure used on historic accounting information. This is shown in illustration 1 under Appendix 1 where the return on investment of Company A in Division C is analysed. Advantages of Return on Investment measurement
It can be used to make comparison among divisions with different lines of business and sizes. II.
Decisions taken by a division to increase its ROI may increase the overall profitability of the organisation. III.
This measure draws the attention of the divisional manager on the assets employed in the divisions and motivates more investment in assets that an adequate return can be derived on them A division can improve ROI in two ways;
The profit margin earned per sales dollar can be increased....
Bibliography: Shim J K, Siegel J G, Dauber N A, (2008), 2008-2009 Edition, Corporate Hand book of Financial Management, CCH Incorporated, Pg 9 - 639
Kaplan R & Norton D, (1992), The balanced scorecard - Measures that drive performance, Harvard Business Review, 71-79.
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