ROI has a distinct advantage over income as a measure of performance since it considers both income (the numerator) and investment (the denominator).
or The breakdown of the formula shows that managers can increase return by more profit and/or generating more sales for each investment dollar. ROI = Income Invested capital ROI = Income Sales x Sales Invested capital Profit Margin Investment Turnover
Measuring the Performance of Investment Centers Margin : portion of sales available for interest, taxes and profit Turnover : how productively assets are being used to generate sales
D. Residual Income (RI) as an Alternative to ROI
Residual Income = NOPAT – Required Profit
= NOPAT – Cost of Capital x Investment
= NOPAT – Cost of Capital x (Total Assets – Noninterest Bearing Current Liabilities)
Residual Income (RI) overcomes the underinvestment problem of ROI since any investment earning more than the cost of capital will increase residual income.
Measuring the Performance of Investment Centers
the difference between operating income and the minimum Rs. return required on a company’s operating assets