Page 331 - PM Integrated Workbook 2018-19

Divisional performance measurement and transfer pricing

1.3 Evaluation of ROI as a performance measure

 It is widely used and accepted since it is in line with ROCE which is frequently
used to assess overall business performance.

 As a relative measure it enables comparisons to be made with divisions or
companies of different sizes.

 It can be broken down into secondary ratios for more detailed analysis, i.e. profit
margin and asset turnover. (as seen in chapter 11)

 It may lead to dysfunctional decision making, e.g. a division with a current ROI
of 30% would not wish to accept a project offering a ROI of 25%, as this would
dilute its current figure. However, the 25% ROI may meet or exceed the
company’s target.

 ROI increases with the age of the asset if NBVs are used, thus giving managers
an incentive to hang on to possibly inefficient, obsolete machines.

 It may encourage the manipulation of profit and capital employed figures to
improve results, e.g. in order to obtain a bonus payment.

Illustrations and further practice

Now try TYU 2 ‘Disadvantages of ROI’.

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