Page 73 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Return on Investment (ROI) Analysis

The return on investment is defined simply as the ratio of profit to investment:
Profit
ROI =
Investment
For example, if profit is ` 60,000 and investment is ` 400,000, the rate of return on investment is
60000/400,000 = 15 percent.
With reference to responsibility accounting, the ROI will be the segment return on investment
(SROI). Symbolically,
Segment Profit Contribution
SROI =
Segment resources/assets

The segment return on investment can be used both for operating performance measurement
and managerial evaluation. Accordingly, there are two variations of segment return on
investments, namely:
Segment profit contribution before interest
1. SROI (operating) =
Segment total assets
Segment profit contribution after interest
2. SROI (net) =
Segment net assets
The operating SROI is used for evaluating the total earning power of all assets directly employed
by a segment regardless of the mode of finance, whereas, net SROI is an indicator of a division's
ability to generate profit contributions in excess of direct cost of financing its operations.

Again, SROI can be viewed as the product of two components namely: segment profit contribution
margin and segment assets turnover.

Segment Profit Contribution Segment Sales Revenue
SROI = ×
Segment Sales Revenue Segment Assets

Any action is beneficial that boosts sales, reduces assets or reduces costs while holding the other
two factors constant.
Advantages

There are several advantages in using ROI to measure divisional/segment performance. These
are as follows:
1. ROI is the generally accepted measure of overall performance. On a single page, the
operating manager may get a summary of his entire controllable items, net earnings and
investment. In one single figure, both the effectiveness and the efficiency of the division
are highlighted.
2. ROI is a common number which can be used to compare divisions with each other, to
measure the achievement of objectives and to use as a basis for rewarding good
performance.
3. ROI is easily understood. The operating manager knows that he can improve ROI by
improving - margins and by exercising better control over assets.

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