Measuring & Controlling

Assets Employed
 Measuring & Controlling
Assets Employed

2 methods

ROI EVA
 Purpose of the Analysis

1 To Provide information for sound financial decisions

2 To measure performance of the business

 The Lesson

Focusing on Profit without considering the Assets

Employed is an inadequate basis for Control
BU Manager’s Performance Objectives

1 Generate Adequate profit on resources

2 Invest in additional resources when they

Provide adequate return
 Business Unit Financial Statements

Assets (Rs in 000)

Liabilities Balance Sheet

Current Liabilities Current Assets

Accounts Payable 90 Cash 50
Receivables 150
Other Current 110 Inventory 200

Total Current Liabilities 200 Total Current Assets 400

Fixed Assets
Corporate Equity 500 Cost 600
Depreciation 300

Book Value 300

Total Equity 700 Total Assets 700

Income Statement

Sales 1000

Expenses 850
Depreciation 50 900

Income Before Taxes 100

Capital Charge 500x 10% 50

Economic Value Added 50

ROI= 100/500=20%
 Return on Investments

ROI is a ratio where the numerator is income

and the denominator is assets employed

ROI= Profit/Sales x Sales/Capital Employed

 Economic Value Added

EVA is an amount rather than ratio. It is derived by

Subtracting a capital charge from net operating profit

EVA= Net Profit- Capital Charge

Capital Charge= Cost of Capital x Capital Employed

EVA= Capital Employed (ROI-Cost of Capital

Measuring Assets Employed
Measuring Assets Employed—2 0bjectives

What Practices induce BU Managers to use their

Assets more efficiently and acquire new Assets?

What Practices best measure the Performance

as an Economic Entity ?
 Business Unit Financial Statements

Assets (Rs in 000)

Liabilities Balance Sheet

Current Liabilities Current Assets

Accounts Payable 90 Cash 50
Receivables 150
Other Current 110 Inventory 200

Total Current Liabilities 200 Total Current Assets 400

Fixed Assets
Corporate Equity 500 Cost 600
Depreciation 300

Book Value 300

Total Equity 700 Total Assets 700

 Assets Employed

Receivable Investments
Cash

Property,
Working Plant &
Capital Equipments
 Assets Employed

Cash
•Better to have Central Control
•Can be % of Sales
•Can be equivalent to monthly sales
•Few companies omit cash from
investments
 Assets Employed

Receivable

•What is the credit limit ?

•Whether CP or Sp?
 Assets Employed

Inventories

•What rate, Cost or SP ?

•LIFO/FIFO or Standard Price
•WIP-advance payments
•Inventory-a/c payables
 Assets Employed

Working
Capital
•Whether to include CA in Investments?

•Whether to include WC in investments ?

 Assets Employed

Property,
Plant &
•Acquisition of New Equipments Equipments
•Gross Book Value
•Annuity Depreciation
•Other Valuation Methods
•Leased Assets
•Idle Assets
•Intangible Assets
•Non-Current Liabilities
•Capital Charge
•Survey of Practices
ROI & EVA
Benefits of ROI

•Comprehensive Ratio
•Simple to Calculate
•Common denominator
Benefits of EVA

•Profit as objective
•Strong correlation with market Value
 Increasing EVA

 Divesting Assets where ROI is less than COC

 Increasing ROI through BPR
 Aggressive new investment in Assets where ROI
is more than COC
 Increase Sales, Profit Margin or Capital efficiency
Ratio
 Difference Between ROI & EVA

ROI
Business Cash Receivable Inventories Fixed Assets Total Investments Budgeted Profit ROI
Unit
A 10 20 30 60 120 24 20%
B 20 20 30 50 120 14.4 12
C 15 40 40 10 105 10.5 10
D 5 10 20 40 75 3.8 5
E 10 5 10 10 35 ( 1.8) (5)

EVA
1 2 3 4 5 6 7
Business profit Amount Rate Req.Earnings Amount Rate Req Earnings Budgeted EVA
Unit Potential (1)-{ (4)+( 7 )

A 24.0 60 4% 2.4 60 10% 6.0 15.6

B 14.4 70 4 2.8 50 10% 5.0 6.6
C 10.5 95 4 3.8 10 10 1.0 5.7
D 3.8 35 4 1.4 40 10 4.0 (1.6)
E 1.8 25 4 1.4 10 10 1.0 (3.8)
Use of EVA in Planning and Control

Strategic Direction
Acquisition
Operational Improvement
Product Line Discontinuation
Working Capital Focus
Cost of Capital Focus
Incentive Compensation
Evaluating EC Performance of the Equity

Diagnostic instruments

Basis for value of company as a whole

Focus on future Profitability

 Case
Discussion

Dell Marden
Computers Company