This lesson provides an in-depth examination of the key financial performance measures used to evaluate investment centres: Return on Investment (ROI), Residual Income (RI), and Economic Value Added (EVA). These metrics are central to the US CMA syllabus and are extensively covered in both US and European management accounting curricula .
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Return on Investment (ROI): ROI is a performance measure that takes into account both operating income and the assets invested to earn that income . It is a widely used metric for evaluating investment centres. The formula is:
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ROI = Operating Income / Assets Invested
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Assets invested are typically the average of the beginning and ending asset balances for the period .
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ROI can also be broken down into its components: ROI = Profit Margin × Asset Turnover .
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Profit Margin (Operating Income / Sales) represents the percentage of each sales dollar that results in profit .
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Asset Turnover (Sales / Average Assets) indicates the productivity of assets or the number of sales dollars generated per dollar invested .
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Residual Income (RI): Residual income is the operating income that an investment centre earns above a minimum desired return on invested assets . The formula is:
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RI = Operating Income – (Desired ROI × Assets Invested) .
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RI encourages managers to accept projects that yield returns above the minimum required rate, addressing a key limitation of ROI.
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Economic Value Added (EVA): EVA is an indicator of performance that measures the shareholder wealth created by an investment centre . It is a more sophisticated measure than RI because it uses after-tax operating income and the cost of capital . The formula is:
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EVA = After-Tax Operating Income – (Cost of Capital × (Total Assets – Current Liabilities)) .
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Managers can improve EVA by increasing sales, decreasing costs, decreasing assets, or lowering the cost of capital .
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EVA is recognised in both the US CMA syllabus and European university curricula as an advanced performance measure .
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