Solution
Robert answered on
Dec 23 2021
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SUNDERLAND BUSINESS SCHOOL
Module Strategic Management Accounting
APC309
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Course:
Word Count: 2878 words
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Part a.
You are required to critically evaluate the following statement:
“Both Return on Investment (ROI) and Economic Value Added (EVA), when used as
performance measures in an organization, encourage managers to be short-term in their focus
and decision making”.
If your critical evaluation tends to agree with the statement,
iefly outline how the short
term nature of such measures can be overcome.
Solution:
Finance is the lifeblood of the business, the efficient management of the finances in order
to properly utilize and manage them is known as financial management. It provides a harmony
etween the enterprise goals and the individual motives by applying the functions of controlling
and planning function in the management of finance. The measurement of the appropriate
utilization of the finances of a company can be done by various measures which have their own
advantages and disadvantages.
In this competitive world, it is very essential for an organization to measure its
performance and achieve its objectives effectively. Performance measurement is a systematic
process of information collection about the organization and reporting the same to the interested
parties. It takes into account the matching of the actual performance with the intended. A
manager has great amount of responsibility for taking the right decision, and measuring the
performance of the organization for achievements of its goals. Measuring the performance of the
organization is beneficial for creating structural approach and reviewing the goals, success and
accountability. The information which is measured is used for setting goals, detecting and
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co
ecting the problems, and accomplishing the documents. To have an insight into the
performance of an organization several types of tools are available. There are many measures
which can be used for the measurement such as return on investment, economic value added,
alance scorecard etc.
ROI stands for return on investment; it is the measurement of the profit in relation to the
capital invested. It is one of the easiest methods to understand and provides quick view of the
profits earned and the adjustment of its assets. The return on investment is calculated by dividing
the controllable profit by the controllable investment.
ROI (Return on Investment) = Controllable Profit/ Controllable Assets.
ROI as a measure of performance is used by many organizations as it tends to take the
information from the financial statements of the company which are available readily to them. It
is a common criterion which is used by the investors and managers to analyze the overall
performance of the organization and thus help them in making decisions. The managers are more
interested in the returns an investment will give them, and ROI satisfy their criteria. Due to its
advantages such as simplicity, consistency and uniformity it has gained importance. As we know
it is the simplest way of calculating a firm‟s performance, on the other hand it is also used by the
management as a reward system. Due to the personal financial interest of the managers, ROI
alignment with business decisions is proved to be better.
However apart from the various advantages ROI offers in the measurement of the
performance, it also suffers from many limitations. It provides an inaccurate position about the
company‟s actual position, as with the increase in the usage of an asset, the ROI tends to
increase, as with time the asset losses its value in the form of depreciation but the profitability
doesn‟t, thus increasing the ROI. This makes the managers to stick with the old and outdated
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machinery, and reduction in the actual performance of the organization. The major criticism of
using the ROI is its short term nature, in order to maximize the ratio in the short term; the long
term perspective is ignored, resulting in an ignorance of absolute amount of profits.
Manipulation on the part of managers become prevalent, as their personal interest is related to a
high ROI. The performance of an organization using ROI encourages managers to be short term
in their approach for decision making. The managers will try to make decisions taking into
consideration the short term goals, and will be encouraged to overestimate the returns by raising
the divisional ROI so as to discourage the divisional incentive.
On the other hand EVA stands for economic value added; it is also one of the measures
for performance of the organization. It is a value based measure to evaluate a company‟s capital
projects, strategies and profitability. It is also the responsibility of the managers to take decisions
that add value to the company‟s long term objectives. The economic value added also measures
the performance targets and has a link with the reward system. It focuses on the end result rather
than the process of reaching there, thereby, encourage managers to be short-term in their focus
and decision making. The EVA is calculated by subtracting net operating profit after taxes
(NOPAT) - (Capital * Cost of capital).The Eva model has a major disadvantage that makes the
managers attracted towards the short term goals, if the model doesn‟t include the cash
adjustments, the accrual distortions are crop up resulting into boosting of profits. Coca- Coal
Company uses EVA as a measuring tool for its organizational performance as its main aim is to
increase its stock price
The statement that” both Return on Investment (ROI) and Economic Value Added
(EVA), when used as performance measures in an organization, encourage managers to be short-
term in their focus and decision making” is true. It is very essential to look at the achievement of...