ROI vs EVA - Kaplan R Atkinson A(1998 Financial measures of performance Return On Investment(ROI and Economic Value Added(EVA En Advanced management

ROI vs EVA - Kaplan R Atkinson A(1998 Financial measures of...

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Kaplan, R., Atkinson, A. (1998). Financial measures of performance: Return On Investment (ROI) and Economic Value Added (EVA). En Advanced management accounting ( pp.499 - 550 ) (798p.)(3a ed). Riverside : Prentice Hall. (C22724) 10 Financia} Measures of Performance: Return on Investment (ROl) and Economic Value Added ([email protected] RELATING PROFITS TO ASSETS EMPLOYED In most decentralized profit centers (or strategic business units, as they are often called), the general manager has authority to not only mak:e operating decisions on product mix, pricing, customer relationships, and production methods but also to determine the level and type of assets used in the unit. For such units, the financial measure used to evaluate managerial and business unit performance should relate the amount of profit earned to the level of assets employed. By measuring a unit's profits relative to the assets employed, corporate managers can assess whether the profits are generating an adequate return on the capital invested in the unit. Capital always has alternative uses, so corporate managers must be concemed about whether the returns being earned on invested capital in a business unit exceed the cost of this capital, as measured by the returns available from altemative uses. A second reason for measuring the returns on capital is to promote discipline in the organization's capital- budgeting process. Most companies have elaborate systems for authorizing capital expen- ditures (see discussion in Chapter 12). Without sorne form of measurement of the ex post returns to capital, little incentive may exist, during the capital-budgeting process, for busi- ness unit managers to estimate accurately the future cash flows. Measuring returns rela- tive to invested capital also focuses managers' attention on how to reduce the levels of working capital-particularly accounts receivable and inventory-used by the decentral- ized unit. 499
500 Chapter 1 O Financia( Meas u res of Performance: Retum on lnvestment and Economic Val u e Added A HISTORICAL PERSPECTIVE Despite the intuitive appeal of a measure that relates profits to employed assets, it was not until the early part of the twentieth century that the return-on-investment criterion was de- veloped. Although business firms used net earnings to measure performance long before 1900, earnings were measured relative to either sales revenue or the costs of operations. They were not measured relative to the organization's investment in productive assets. 2 The typical nineteenth-century owner-entrepreneur-whether of a textile mili, a railroad, a steel company, ora retail organization-had to concentrate on performing only a single type of economic activity efficiently. In the short run, the owner attempted to manage operating costs in this single activity. He did not have to choose among altemative types of activities in which to make investments. He only had to determine the appropriate scale of activity in bis principalline of business. For this purpose, the operating ratio of costs to revenues or the return on sales apparently provided an adequate guide for investment profitability.

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