Friday 11 december 5 11 /12 /Dec 00:13

Divisional Performance Evaluation

ROI or ROCE (Return on Ivestment or Return on Capital Employed)

Residual Income

Budget v Actual

Cash Recovery Rate

NFI's (Non Financial Indicators)

Value Added





ROI or ROCE

 

ROI = ∏ / Κ  (Profit / Capital)

Earnings before interest payments & tax / Assets (EBIT / Assets)

Need to Be Consistent with the formula you use.

Problems,
Deprication (annuity is best)
Inflation (distorts results)
Asset Base
Relative to Size

In this formula the profit should be:

gross figure before deducting tax.
not reduced by debenture interest.
not include non trading items, such as Rent Income.

In this formula Capital Employed should be

from the balance shhet.
it can be equity, maybe include debentures, fixed assets plue net current assets, iclude goodwill?

these need to be considered and you need to be consistent with how it is calculated.




So Assets......

ROI is only relevant if the division is an investment centre.

 

just incase you don't know what an investment centre is, here goes.

 

3 levels of centre

Cost

Profit

Investment

 

Cost Centre - only takes into account the cost

Profit Centure - takes into account costs and revenure

Investment Centre - takes into account costs, revenues and investments.

 

 

there are many ways to value assets.

 

cost, replacement cosy, econmic value, not or gross book value. etc. Assets need to be valued consistently.

if the assets are leased only include long leases not short.


Advantages and Disadvantages of ROI

Advantages

 

Focus on Profit

Objective to cost and Profit

Readily available data

Relevant

Different sized divisions, it is fair to different sizes.

Managers accept projects with higher ROI's

 

 

Disadvantages

 

Historic Measure

Accounting Policies

NPV (net present value) is the best decision criteria, not ROI

Ignores risk

Projects which have a slow payoff maybe rejected.

 

 

 

Residual Income

much better that ROI as it gets rid of disfunctional decisions.

 

RI = ∏ - (K x %) % is the most likely to occur.



Divisional Performance Statement

Sales                                           X

less variable costs                      (X)

contribution                                 X
lass controllable FC                     (X)

controllable RI                              X

less uncontrollable costs             (X)

less interest on non                     

controllable investment               (X)

net residual income                      X

 

 

RI gives better decision making

Includes the opportunity of funds

encourages functional decision

manager only accepts projects where the rate of return exceeds the cost of capital

 

 

Residual Income Advantages and Disadvantages

Advantages

 

readily available data

reduces dysfunctional behavious

reflection of different levels of risk

 

Disadvantages

 

which rate of notional interest to use?

not relevant to external users

what to do about projects with a slow payoff?

historical data used

not objective

makes comparison difficult.

 

Other Evaluation Methods


Cash recovery rate

cash from operations / gross assets   (cash/assets)

 

NFI's

eg sales growth, market share, new products.

this is essential to any comprehensive performance evaluaton.

 

Value Added

sales value of good or services, less cost of inputs.

 

 

 

Sorry this isnt great, but i am just working from my lecture notes and trying to make sense off it all.

let me know if you want more, i can use a text book or something to expand if you guys want me to.

   

 

 

 

By Becky Trafford - Posted in: Education - Community: Accounting Students
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