Return on Investment (ROI) and Economic Value Added (EVA)

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Return on Investment (ROI) and Economic Value Added (EVA)

Although ROI and EVA are the techniques used to evaluate a companys performance, comparing and contrasting them can help understand why managers choose one over the other depending on particular situations. Both approaches measure organizations profitability and value, vital in making the decisions related to planning management incentives, compensation strategies, and capital investment (Al-Afeef, 2017). Additionally, ROI and EVA can be used to evaluate the performance of different departments depending on each units assets or resources and the revenue it generates. Therefore, managers can use either of the two techniques to know how their firms are doing and plan how to optimize operations. Nevertheless, while managers use ROI to measure generated income proportionate to the invested capital, they adopt EVA to evaluate how effective assets are utilized to generate income (Al-Afeef, 2017). Moreover, whereas ROI is calculated after deduction of tax and interest from the profit, EVA uses profit before subtraction of tax and interest.

As a manager, the best method to use to measure an organizations performance is the ROI. This technique can be instrumental when comparing the performance of different units and planning and implementing the way each departmental manager can maximize profits based on the investments made in assets (Al-Afeef, 2017). For instance, if two departments, A and Bs, operating income is $4295 and $5952 and average operating assets are $30390 and $60420, respectively, As ROI would be 14.13 % and Bs ROI 9.85 %. In this case, unit As managers perform better than the one in unit B even though operating income is significantly low.

The ROI approach to measuring organizational performance is associated with numerous advantages. The technique is a better measure of profitability since it relates net income to investments made by an organization (Davis & Davis, 2019). Additionally, it facilitates comparison between various firms units in terms of asset utilization and profits made from operations. Conversely, the disadvantage of using EVA is that it cannot effectively evaluate the utilization of capital assets (Davis & Davis, 2019). Moreover, it is hard to evaluate the return on such expenses as research and development when using EVA.

References

Al-Afeef, M. (2017). The impacts of economic value added & return on investment on the changes in the stock markets value (Analytical study: ASE: 2006-2015). International Journal of Business and Management, 12(10), 132. Web.

Davis, C., & Davis, E. (2019). Managerial accounting (4^th ed.). Wiley.

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