ACT 220 Ch 10 Performance Evaluation

Economic Value Added (EVA)

A concept similar to residual income in which a variety of adjustments may be made to GAAP financial statements for performance evaluation purposes. --When residual income or EVA is used to measure performance, the objective is to maximize the total amount of residual income or EVA, not to maximize ROI.

manufacturing cycle efficiency (MCE)

MCE= value-added time (process time)/ throughput (manufacturing cycle) time the goal is to increase this measure

The Return on Investment (ROI) Formula

Net Operating Income / Average Operating Assets ROI= margin X turnover margin= net operating income/sales turnover= sales/ average operating assets -The higher a business segment's return on investment (ROI), the greater the profit earned per dollar invested in the segment's operating assets.

margin

Net Operating Income / Sales

balanced scorecard

an integrated set of performance measures that are derived from and support the organization's strategy Financial measures, such as ROI and residual income, and operating measures, such as those discussed in the previous section, may be included

decentralized organization

an organization in which decision-making authority is not confined to a few top executives but rather is spread throughout the organization

responsibility center

any business segment whose manager has control over costs, revenues, or investments in operating assets -cost centers, profit centers, investment centers

True or false: when considering ROI, excessive operating expenses is always of greater concern to managers than excessive operating assets

false

True or false: Adams, inc. has found that their managers are reluctant to replace old equipment with new, updated equipment. To stop this practice, Adams should compute ROI using assets' net book value

false, net book value discourages equipment replacement

Net Operating Income

income before interest and income taxes have been deducted sometimes referred to as EBIT earnings before interest and taxes

Throughput (Manufacturing Cycle) Time

the elapsed time from when production is started until finished goods are shipped The goal is to continuously reduce this measure Throughput (manufacturing cycle) time=Process time+Inspection time+Move time+Queue time Only one of these four activities adds value to the product—process time. The other three activities—inspecting, moving, and queuing—add no value and should be eliminated as much as possible.

Residual Income

the net operating income that an investment center earns above the minimum required return on its operating assets net operating income- (average operating assets x min rate of return)

turnover

Sales / Average Operating Assets

Delivery Cycle Time

The elapsed time from when a customer order is received until the finished goods are shipped The goal is to reduce this measure Delivery cycle time=Wait time+Throughput time

profit center

a business segment whose manager has control over cost and revenue but has no control over investments in operating assets -these managers are often evaluated by comparing actual profit to targeted or budgeted profit.

cost center

a business segment whose manager has control over cost but has no control over revenue or investments in operating assets ex. service departments such as accounting, finance, general admin, legal, and personnel. manufacturing facilities -evaluated on their ability to control costs in their responsibility center

investment center

a business segment whose manager has control over cost, revenue, and investments in operating assets -managers are often evaluated using return on investment (ROI) or residual income measures.

Operating Assets

cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes -Most companies use the net book value (i.e., acquisition cost less accumulated depreciation) of depreciable assets to calculate average operating assets --An alternative to using net book value is the gross cost of the asset, which ignores accumulated depreciation.

using net book value (instead of gross cost) to calculate average operating assets:

increases ROI over time (as accumulated depreciation increases, net book value decreases. this decreases the ROI calculation denominator and increases ROI)