Return on Investment in Cost Accounting
Return on investment (ROI) as it relates to cost accounting measures the profit generated using the operating assets of a business as a formula-derived ratio. ROI is one of the most frequently used performance measurements in the corporate world. By measuring ROI, managers can view profitability in relation to the size of the investment. This information can help the company determine if the investment is the best use of the corporation's money or if it would be better to invest in something else.ROI is commonly calculated by dividing net operating income into average operating assets.
ROI can also be broken down in terms of margin and turnover. Margin is the profit from the sale of a good minus all of the expenses of selling and manufacturing the good, expressed as a dollar figure or percentage. Investment turnover is the measure of a company's sales divided by the invested capital. Managers use turnover to determine how effective the asset is in generating sales.Managers often express ROI in terms of margin and turnover.
Return on Investment Formula
Return on Investment as a Performance Measure
Evaluating ROI can be an important part of measuring how effective a manager of an investment center is within a business. Managers have many responsibilities and many different ways that they can affect costs and expenses in relation to the assets they manage. ROI provides a way to distill these many responsibilities down into a single number that can then be compared to the returns of the investment center itself previously, the returns of managers of other investment centers within the same organization, or the returns of similar companies within the same industry.
While ROI is an important performance measurement, a company may not want to rely on it as the only method to evaluate an investment center's management performance. Telling a manager to increase ROI at all costs may not work if the manager does not know how to increase ROI effectively. Also, the manager may act to increase ROI in ways that run contrary to the company's overall corporate strategy. For example, a manager may increase ROI in the short term by cutting back on future-focused costs, such as research and development. Such action would likely reduce long-term ROI because the company would fall behind its competitors' product offerings. This situation depends on whether competitors continue to invest in research and development and whether they do so at a higher level than the manager's company does.
Managers also may have committed costs within their investment center that they have no control over because of choices made by prior managers or because of overall corporate strategy. This may limit the ways in which they can act to improve ROI, or it may make their current ROI numbers look comparatively weaker than they truly are. For instance, if a previous manager tried to trim expenses by buying outdated or inferior raw materials, then the current manager may have some hard decisions to make. The company may lower its prices on certain items or sell off those raw materials in an attempt to get back on track again.
Finally, managers may feel pressure to pursue opportunities that benefit the ROI of their investment center but have a negative impact on the ROI for the company as a whole. For example, a company may have two divisions that produce complementary products, such as a home water softener systems division and a water coolers and bottled water division. The manager of the home water softener systems division may decide to start selling residential home water filters that will allow customers to filter their own tap water and eliminate the need for them to buy water coolers and bottled water. This action may increase the ROI of the home water softener system division. However, it will reduce the ROI for the company overall because it will lessen sales of water coolers and bottled water, therefore harming the ROI of that division.