Share article Management Accounting - Divisional Performance Evaluation: Divisional Performance Evaluation ROI or ROCE (Return on Ivestment or Return ...
Divisional Performance Evaluation
ROI or ROCE (Return on Ivestment or Return on Capital Employed)
Budget v Actual
Cash Recovery Rate
NFI's (Non Financial Indicators)
ROI or ROCE
ROI = ∏ / Κ (Profit / Capital)
Earnings before interest payments & tax / Assets (EBIT / Assets)
Need to Be Consistent with the formula you use.
Deprication (annuity is best)
Inflation (distorts results)
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.
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 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
Focus on Profit
Objective to cost and Profit
Readily available data
Different sized divisions, it is fair to different sizes.
Managers accept projects with higher ROI's
NPV (net present value) is the best decision criteria, not ROI
Projects which have a slow payoff maybe rejected.
much better that ROI as it gets rid of disfunctional decisions.
RI = ∏ - (K x %) % is the most likely to occur.
Divisional Performance Statement
less variable costs (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
readily available data
reduces dysfunctional behavious
reflection of different levels of risk
which rate of notional interest to use?
not relevant to external users
what to do about projects with a slow payoff?
historical data used
makes comparison difficult.
Other Evaluation Methods
Cash recovery rate
cash from operations / gross assets (cash/assets)
eg sales growth, market share, new products.
this is essential to any comprehensive performance evaluaton.
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.