Tag: Business economics

Activity based budgeting is a budgeting method in which budgets are prepared using Activity Based Costing after considering the overhead costs. Activity-based budgeting (ABB) is a budgeting method where activities are thoroughly analyzed to predict costs. ABB does not take historical costs into account when creating a budget. In simple words, activity-based budgeting is management accounting tool which does not consider the past year’s budget to arrive at current year’s budget. Instead, the activities that incur the cost are deeply analyzed and researched. Based on the outcome of the study, the resources are allocated to an activity. Activity-based budgeting (ABB) is more rigorous than traditional budgeting processes, which tend to merely adjust previous budgets to account for inflation or business development.

Components

Components and Process of Activity Based Budgeting are given below:

• It starts with identifying activities which revolve around resource consumption and these activities are mainly classified as main activities and secondary activities which denotes to the degree of involvement and importance of an activity to the organization as per their priority, therefore, main activities are activities which are directly related with the objectives and are essential.
• Secondary activities are those activities that create added value to the customer and change its preference in the organization’s favor which may involve a significant number of resources.
• After defining the activities, the next task is to identify how to distribute the costs or resources accordingly among the activities which are done with the help of inducers which are factors defining the level of consumption in different activities.
• Mainly three such inducers influence such decisions which are time which depicts the duration for the processes, number of resources required by each activity and lastly the number of times an activity is repeated after getting all these facts the appropriate costs can be calculated.

Importance

Improves Relationship

Activity based budgeting system helps in improving the relationship between the organization and its customers. The main aim of this budgeting method is to eliminate unnecessary activities and serve the customers with the best quality at best price. This enforces (indirectly) the employees of the company to serve the customers in the best way possible and ensure customer satisfaction. In turn, the relationship between the organization and the customers improves.

Evaluation

Activity based budgeting method evaluates each and every cost driver. It takes into consideration all the steps involved in an activity. The irrelevant activities are eliminated and only the necessary activities form a part of the business.

Elimination of Bottlenecks

Budgets under activity-based budgeting are prepared after deep research and analysis. This study removes all the unnecessary activities of the business. By doing so, the business eliminates all sorts of bottlenecks associated with an activity and business functions are carried out more smoothly.

Business as a Unit

This budgeting technique helps in viewing the business as a single unit and not in the form of departments. The managers or the top management prepare the budget for the business unit as a whole and not keeping in mind any single department as done in the case of other methods of budgeting.

Competitive Edge:

Activity based budgeting system eliminates all sorts of unnecessary activities, which helps the business to save its costs. The saved cost results in the production of goods and services at lower cost than that of competitors. It also helps the organization to gain a competitive edge in the market.

Issues, Limitations

• It is based on forecasting with the use of historical data and future expectations which may sometimes prove to be unreliable if the situations or scenarios planned do not come out to be what was expected to lead to problems that can hamper the entity and its resources.
• It requires a well-groomed talented team of individuals who are experts in finding gaps and are equally competent in reporting and use of the necessary software as it is a complex process on which the direction of the company is dependent.
• Activity-Based Budgeting is a lengthy and comprehensive process that requires a considerable amount of time and resources on an entity and spending too much on analyzing may prove to be counterproductive.
• Activity-Based Budgeting provides only supplemental information.
• While preparing an Activity Based Budget it is possible that the axis of focus may shift to immediate and short term results and the bigger picture may be ignored causing damage in the long term.

Process

The activity-based budgeting (ABB) process is broken down into three steps.

• Identify relevant activities. These cost drivers are the items responsible for incurring revenue or expenses for the company.
• Determine the number of units related to each activity. This number is the baseline for calculations.
• Delineate the cost per unit of activity and multiply that result by the activity level.

Activity-based management (ABM) is a method of identifying and evaluating activities that a business performs, using activity-based costing to carry out a value chain analysis or a re-engineering initiative to improve strategic and operational decisions in an organization.

Activity-based management follow this premise: products consume activities; activities consume resources. If managers want their products to be competitive, they must know both:

(i) The activities that go into making the goods or providing the services

(ii) The cost of those activities.

To reduce a product’s cost, managers will likely have to change the activities the product consumes.

Activity-based costing is defined as a methodology that measures the cost and performance of activities, resources and cost objects. Specially, resources are assigned to activities based upon consumption rates and activities are assigned to cost objects, again based on consumption. ABC recognizes the causal relationships of cost driver to activities.

Activity-based management is defined as a discipline that focuses on the management of activi­ties as the route to improving the value received by the customer and the profit achieved by provid­ing this value. ABM includes cost driver analysis, activity analysis, and performance measurement, drawing on ABC as its major source of data.

In simple terms, ABC is used to answer the question “what do things cost?” While ABM, using a process view, is concerned with what factors cause costs to occur? Using ABC data, ABM focuses on how to redirect and improve the use of resources to increase the value created for customers and other stakeholders.

Model

• Cost Driver Analysis: For the purpose of managing the activity costs, the factors that result in the activities to take place are to be identified.
• Activity Analysis: Activity Analysis is all about finding out the activities of the organizations and its centres, that are ought to be utilized in the activity-based costing. Based on the costs and benefits of the alternatives, the activities are divided into the number of activity centres. Further, it ascertains value added and non-value added activities:
• Value Added Activities: The activities which are very essential for the completion of the process are categorized as value-added activities.
• Non-Value Added Activities: Those activities which are not having any worth for both external or internal customers are termed as Non-value added activities. Indeed these activities do not enhance the quality of the product rather they have a negative impact on the cost and prices of the product or services as they create wastes, delays, increase the overall value etc.
• Performance Analysis: It involves discovering a proper measure to analyse the performance of the activity centres.

Importance

• Performance Measurement: Nowadays, most of the firms concentrate on activity performance by observing the efficiency and effectiveness of activities, so as to compete successfully in the market.
• Cost Reduction: Activity-based management facilitates the organization to identify the costs against activities to determine the ways to reduce costs and even eliminate the entire activity if it is not adding any value to the products.
• Business Process Reengineering: It entails examining and redesigning the processes and workflows of the organisation for improving the performance and also gaining excellence in business operations. It involves making significant changes regarding the way in which organisation operates currently. ABM helps in improving the business process efficiency and effectiveness.
• Activity-Based Budgeting: ABB supplies a framework for forecasting the input required as per the budgeted level of activity. A comparison is made between actual results and estimated results to outline the activities with a high level of variances from the budget for a probable reduction in the supply of inputs.
• Benchmarking: Benchmarking is the process of making a comparison of the products and services offered by the company with that of the other organisations. It aims at identifying the ways to improve products and services of the firm.

Issues, Limitations

The trouble with ABM is its underlying assumption that all of the benefits and costs of a cost object can be translated into monetary terms. For example, the outcome of an ABM analysis might lead management to the conclusion that the workplace should be downgraded to a lower-grade property in order to save money; in reality, a fancier office space is useful for attracting recruits to the company.

For the same reason, it can be difficult to apply ABM to strategic thinking. The problem in this area is that a new strategic direction may be quite expensive in the short-term, but has prospects for a long-term payoff that are difficult to quantify under an ABM analysis.

For the two indicated reasons, the information generated by an ABM analysis cannot be used to drive all management decisions; it is simply information that can then be inserted into the general context of how an organization should be operated. Thus, it is one of several decision tools that management can use.

Risks

A risk with ABM is that some activities have an implicit value, not necessarily reflected in a financial value added to any product. For instance, a particularly pleasant workplace can help attract and retain the best staff, but may not be identified as adding value in operational ABM. A customer who represents a loss based on committed activities, but who opens up leads in a new market, may be identified as a low value customer by a strategic ABM process.

Managers should interpret these values and use ABM as a “common, yet neutral, ground. This provides the basis for negotiation”. ABM can give middle managers an understanding of costs to other teams to help them make decisions that benefit the whole organization, not just their activities’ bottom line.

Backflush accounting is a certain type of “postproduction issuing”, it is a product costing approach, used in a Just-In-Time (JIT) operating environment, in which costing is delayed until goods are finished. Backflush accounting delays the recording of costs until after the events have taken place, then standard costs are used to work backwards to ‘flush’ out the manufacturing costs. The result is that detailed tracking of costs is eliminated. Journal entries to inventory accounts may be delayed until the time of product completion or even the time of sale, and standard costs are used to assign costs to units when journal entries are made. Backflushing transaction has two steps: one step of the transaction reports the produced part which serves to increase the quantity on-hand of the produced part and a second step which relieves the inventory of all the component parts. Component part numbers and quantities-per are taken from the standard bill of material (BOM). This represents a huge saving over the traditional method of:

a) issuing component parts one at a time, usually to a discrete work order.

b) receiving the finished parts into inventory

c) returning any unused components, one at a time, back into inventory.

It can be argued that backflush accounting simplifies costing since it ignores both labour variances and work-in-process. Backflush accounting is employed where the overall business cycle time is relatively short and inventory levels are low.

Backflush accounting is inappropriate when production process is long and this has been attributed as a major flaw in the design of the concept. It may also be inappropriate if the bill of materials contains not only piece goods but also many parts with more or less variable consumption. If the parts with variable consumption are just a few, like grease or the ink used to print product-labels, the consumed quantities can be assigned to product-independent cost centers at the withdrawal from stores (preproduction issuing) and can eventually be broken down afterwards to specific products or product groups, just like any other indirect or overhead expense. Difficulties maintaining correct inventories on shop floor may also appear if it is usual practice to use alternative materials and/or quantities without needing derogation. Therefore, in case of a more complex production system, it is a better approach to use a Manufacturing Execution System (MES) which gathers real production data and is able to deliver exact data to the accounting software or Enterprise resource planning-system where the goods issue is recorded. Thus, variances in consumption, in comparison to the standard bill of materials, are taken into account and assigned to the correct product, production order and workplace. Another advantage of using a MES is that it implements also the Production Track & Trace and the status of work in progress is also known in real time. A disadvantage of MES is that it is not suitable for small series or prototype production. Such type of production should be segregated from the series production and mass production.

Backflush costing is an accounting method that records costs after a good is sold or a service is completed. Backflush costing is common among companies that use a Just-in-Time inventory management system. It avoids the costly and complicated reporting of all expenses as they occur, and instead “flushes” all expenses in a single entry once the production process is completed.

Features

• If the product manufactured involves not only one single product but also many parts along with it with high or low variable consumption, backflush costing becomes inappropriate.
• In backflush costing, the cost of materials is not separately calculated, but it is transferred directly to the finished product account.
• When the units of goods are completed, the material cost is deducted from inventory, and finished goods are transferred to the material account.
• Journal entries in inventory accounts get delayed until the time of production or sale, and the standard costing mechanism is used to assign to units when journal entries are passed.
• The cost of conversion is shared with finished goods inventory account based on the operating time of labor.
• Tracking work in the process is not possible, and no other work account is separately maintained during the process.

Process

• Once a company gets an order, it records only the essential information into the system, such as quantity, delivery date, and the item code. Based on this, the list of materials needed to complete the order is made.
• When the production is about to start, the company takes the delivery of the raw material and shifts it to the production floor.
• Now software does the routing of all the components for that production order. The cost manager still has a say on what parts and how much quantity to push in.
• After the end of the production process, the operator enters all information about the product into the computer. The software then prepares the production report.
• Based on that report, the operator in a single transaction assign materials cost to the production order.

Journal Entry of Backflush Costing

• Simple entry is passed by debiting expenses account and crediting payment a/c i.e., bank or cash A/c or creditor A/c when purchased on credit.
• Finished Goods A/c is debited with all costs incurred in point 1. With corresponding credit above Cost A/cs like Direct Material Cost, processing cost (labor), etc.
• At the time of sales, the cost of corresponding goods which are sold is transferred to the cost of goods Sold with credit to Finished goods A/c.

Backflush accounting is entirely automated, with a computer handling all transactions. The formula for it is:

Number of raw material units removed from stock = (Number of units produced) x (unit count listed in the bill of materials for each component)

Problems with Backflush Accounting

• Requires a fast production cycle time. Backflushing does not remove items from inventory until after a product has been completed, so the inventory records will remain incomplete until such time as the backflushing occurs. Thus, a rapid production cycle time is the best way to keep this interval as short as possible. Under a backflushing system, there is no recorded amount of work-in-process inventory.
• Requires an accurate production count. The number of finished goods produced is the multiplier in the backflush equation, so an incorrect count will relieve an incorrect number of components and raw materials from stock.
• Requires an accurate bill of materials. The bill of materials contains a complete itemization of the components and raw materials used to construct a product. If the items in the bill are inaccurate, the backflush equation will relieve an incorrect number of components and raw materials from stock.
• Requires excellent scrap reporting. There will inevitably be unusual amounts of scrap or rework in a production process that are not anticipated in a bill of materials. If you do not separately delete these items from inventory, they will remain in the inventory records, since the backflush equation does not account for them.

Companies using backflush costing generally meet the following three conditions:

• Short production cycles: Backflush costing shouldn’t be used for goods that take a long time to manufacture. As more time goes by, it becomes increasingly difficult to assign standard costs accurately.
• Customized products: The process is not suitable for the fabrication of customized products since this requires the creation of a unique bill of materials for each item manufactured.
• Material inventory levels are either low or constant: When inventories, the array of finished goods held by a company, are low, the bulk of manufacturing costs will flow into the costs of goods sold, and it is not deferred as inventory cost.

Drawbacks of this costing system are:

• For the results to be accurate, this system needs an accurate production count. In the formula above, the finished goods count is one of the two inputs. So, if this number is wrong, then the resultant figure will not be accurate as well.
• It is relatively difficult to implement.
• Its success also depends on the accuracy of the bill of materials. A bill of material contains the list of all components and raw materials that a product will require. Thus, if there is a discrepancy in the bill of materials, the backflush costing will assign an incorrect amount of raw materials and components.
• Since this system does not record the work-in-process inventory, it needs a fast production cycle time. This costing system does not record inventory until the end of the production. So, during this timeframe, the records will remain incomplete. The only way to ensure records get updated quickly is to shorten or quicken the production cycle.
• Scrap reporting also needs to be accurate. Usually, in a production process, there is a large amount of scrap. The bill of material does not account for this scrap. It is essential to remove these scraps from the inventory to get the right picture.

Investment decision: It is related to capital mix. Firms have scarce resources that must allocated among competitive uses. The financial management provides a framework for firms to take these decisions wisely. The investment decision includes not only those that creates revenues and profits (ex. Introducing product line), but also those that save money (ex. Introduce a more efficient distribution system). The investment decision is the decision related to assets composition of the firm. Investment decision deals with the size and composition of the asset side of the balance sheet. It is also divided into capital budgeting decision (related to fixed asset) and Working capital management (related to current asset).

a) Capital Budgeting: It deals with the size and composition of the fixed assets. The fixed assets of a firm are the primarily determinants of the profitability of the firm. The objective of the capital budgeting decision is to identify those assets which are worth more than their cost. A financial manager therefore has to take utmost care in dealing with the decision.

b) Working capital management: It deals with the management of the current assets of the firms. Though the current asset do not contribute directly to the earnings, yet their existence is necessities for the proper, efficient and optimum utilization of fixed assets. There are the problems of both the excessive working and adequate working capital to the firm. This decision include how much and what inventory to be maintained and how much credit to be given to the customers.

Financing decision: It deals with the financing patterns of the firms. As firms make decisions concerning where to invest resources. They also have to decide how they should raise resources. There are two main resources of finance for any firm, that is shareholders’ funds and the borrowed funds. These sources have their own characteristics. The key distinction between these two resources that the borrowing funds are always repayable but the shareholders’ funds are not always repayable. firms usually adopt a policy of employing both borrowing funds as well as the shareholders’ funds to finance their activities. The employment of these funds in the combination is also known as Financial Leverage. Every such combination has its own implications.

The Dividend Decision: It deals with the appropriation of after-tax profits. These profits are available to be distributed among the shareholders, Or can be retained by the firm for reinvestment within the firm. Every firm, whether it is small or large, have to decide how much of the profits should be reinvested back in the business. And how much should be taken out in form of dividends. these activities are coming under Profit allocation. The distribution of the profits by any firms is required to satisfy the expectation of the shareholders. The profits can be distributed to shareholders either as the Revenue income(ex. expenditure) or as capital receipt(ex. Bonus share). In this attempt the manager has to look into the fund’s requirements of the firms and the shareholders’ interests. so, these are the financial managerial decisions in asset mix, capital mix and profit allocation.

Return on cash Systems

Cash on cash return is a rate of return ratio that calculates the total cash earned on the total cash invested. The amount of the total cash earned is generally based on the annual pre-tax cash flow.

A cash-on-cash return is a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property. Put simply, cash-on-cash return measures the annual return the investor made on the property in relation to the amount of mortgage paid during the same year. It is considered relatively easy to understand and one of the most important real estate ROI calculations.

Cash on cash return is a simple financial metric that allows the assessment of cash flows from a company’s income-generating assets. The ratio is primarily used in commercial real estate transactions. In the real estate industry, the cash-on-cash return is sometimes referred to as the cash yield on a property investment.

The Formula for Cash-on-Cash Return

Cash on Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested

Annual Pre-Tax Cash Flow​where:

APTCF = (GSR + OI) – (V + OE + AMP)

GSR = Gross scheduled rent

OI = Other incomeV = Vacancy

OE = Operating expenses

AMP = Annual mortgage payments​

A cash-on-cash return is a metric normally used to measure commercial real estate investment performance. It is sometimes referred to as the cash yield on a property investment. The cash-on-cash return rate provides business owners and investors with an analysis of the business plan for a property and the potential cash distributions over the life of the investment.

Cash-on-cash return analysis is often used for investment properties that involve long-term debt borrowing. When debt is included in a real estate transaction, as is the case with most commercial properties, the actual cash return on the investment differs from the standard return on investment (ROI).

Calculations based on standard ROI take into account the total return on an investment. Cash-on-cash return, on the other hand, only measures the return on the actual cash invested, providing a more accurate analysis of the investment’s performance.

Transfer Pricing

Transfer price is the price at which related parties transact with each other, such as during the trade of supplies or labor between departments. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities. It is common for multi-entity corporations to be consolidated on a financial reporting basis; however, they may report each entity separately for tax purposes.

In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort taxable income, tax authorities in many countries can adjust intragroup transfer prices that differ from what would have been charged by unrelated enterprises dealing at arm’s length (the arm’s-length principle). The OECD and World Bank recommend intragroup pricing rules based on the arm’s-length principle, and 19 of the 20 members of the G20 have adopted similar measures through bilateral treaties and domestic legislation, regulations, or administrative practice. Countries with transfer pricing legislation generally follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in most respects, although their rules can differ on some important details.

Where adopted, transfer pricing rules allow tax authorities to adjust prices for most cross-border intragroup transactions, including transfers of tangible or intangible property, services, and loans. For example, a tax authority may increase a company’s taxable income by reducing the price of goods purchased from an affiliated foreign manufacturer or raising the royalty the company must charge its foreign subsidiaries for rights to use a proprietary technology or brand name. These adjustments are generally calculated using one or more of the transfer pricing methods specified in the OECD guidelines and are subject to judicial review or other dispute resolution mechanisms.

Although transfer pricing is sometimes inaccurately presented by commentators as a tax avoidance practice or technique (transfer mispricing), the term refers to a set of substantive and administrative regulatory requirements imposed by governments on certain taxpayers. However, aggressive intragroup pricing especially for debt and intangibles has played a major role in corporate tax avoidance, and it was one of the issues identified when the OECD released its base erosion and profit shifting (BEPS) action plan in 2013. The OECD’s 2015 final BEPS reports called for country-by-country reporting and stricter rules for transfers of risk and intangibles but recommended continued adherence to the arm’s-length principle. These recommendations have been criticized by many taxpayers and professional service firms for departing from established principles and by some academics and advocacy groups for failing to make adequate changes.

Transfer pricing should not be conflated with fraudulent trade mis-invoicing, which is a technique for concealing illicit transfers by reporting falsified prices on invoices submitted to customs officials. “Because they often both involve mispricing, many aggressive tax avoidance schemes by multinational corporations can easily be confused with trade misinvoicing. However, they should be regarded as separate policy problems with separate solutions,” according to Global Financial Integrity, a non-profit research and advocacy group focused on countering illicit financial flows.

Risks:

1. There can be a disagreement among the organizational division managers as what the policies should be regarding the transfer policies.
2. There are a lot of additional costs that are linked with the required time and manpower which is required to execute transfer pricing and help in designing the accounting system.
3. It gets difficult to estimate the right amount of pricing policy for intangibles such as services, as transfer pricing does not work well as these departments do not provide measurable benefits.
4. The issue of transfer pricing may give rise to dysfunctional behavior among managers of organizational units. Another matter of concern is the process of transfer pricing is highly complicated and time-consuming in large multi-nationals.
5. Buyer and seller perform different functions from each other that undertakes different types of risks. For instance, the seller may or may not provide the warranty for the product. But the price a buyer would pay would be affected by the difference. The risks that impact prices are as follows

• Financial & currency risk
• Collection risk
• Market and entrepreneurial risk
• Product obsolescence risk
• Credit risk

Benefits:

1. Transfer pricing helps in reducing the duty costs by shipping goods into high tariff countries at minimal transfer prices so that duty base associated with these transactions are low.
2. Reducing income taxes in high tax countries by overpricing goods that are transferred to units in those countries where the tax rate is comparatively lower thereby giving them a higher profit margin.

Divisional Performance

1. The Economic Value Added (EVA)

ROI and RI cannot stand alone as a financial measure of divisional performance. One of the factors contribute to a company’s long-run objectives is short-run profit ability. ROI and RI are short-run concepts that deal only with the current reporting period whereas managerial performance measures should focus on future results that can be expected because of present actions.

RI has been refined and re-named as economic value added (EVA) by the Stern Stewart & Co. EVA is a financial performance measure based on operating income after taxes, the investment in assets required to generate that income and the cost of the investment in assets (or, weighted average cost of capital). The objective of EVA is to develop a performance measure that find the ways in which company value can be added or lost. The EVA concept extends the traditional residual income measure by incorporating adjustments to the divisional financial performance measure for distortions introduced by GAAP. Thus, by linking divisional performance to EVA, managers are motivated to focus on increasing shareholder value.

2. The Residual Income (RI)

Residual income overcomes the dysfunctional aspect of ROI. It is because the use of ROI as a performance measurement can lead to under-investment. For example, a manager currently achieving a high rate of return (say 30 percent) may not wish to pursue a project yielding a lower rate of return (say 20 percent) even though such as a project may be desirable to a company which can raise capital at an even lower rate. Thus, used RI is better than ROI.

The purpose of evaluating the performance of divisional managers, RI is defined as controllable contribution less a cost of capital charge on the investment controllable by the divisional manager. For evaluating the economic performance of the division RI can be defined as divisional contribution less a cost of capital charge on the total investment in assets employed by the division.

Besides, RI is favour than ROI and it more flexible because different cost of capital percentage rates can be applied to investments that have different levels of risk. There is not only will the cost of capital of divisions that have different levels of risk differ so may the risk and cost of capital of assets within the same division. The RI measure enables to calculate the different risk-adjusted in capital cost while ROI cannot incorporate these differences.

While ROI is a ratio, RI is an absolute figure. RI deals with the problems of ROI adequately because any investment, which will earn higher than the capital charge will improve the RI. Therefore, use of RI motivates divisional managers to acquire only those assets, which will improve the performance of the company as a whole. Thus, the RI method sets the same profit objective for same assets in different divisions.

A sophisticated system also solves the problem of the same profit objective for different assets in the same division by using different rate of capital charges for different class of assets. RI is definitely a superior measure compared to ROI for measuring divisional performance.

3. The Return on Investment (ROI)

Nowadays, most of companies concentrate on the return on investment (ROI) of a division that is profit as a percentage in direct relation to investment of division which instead of focusing on the size of a division’s profits. ROI addressed divisional profit as a percentage of the assets employed in the division. Assets employed can be defined as total divisional assets, assets controllable by the divisional manager, or net assets.

The main advantage of using ROI is provides a valuable information about the overall approximation on the success of a firm’s past investment policy by providing a abstract of the ex post return on capital invested. According to Kaplan and Atkinson, they state that however, lack of some form of measurement of the ex post returns on capital, there is still useful for accurate estimates of future cash flows during the capital budgeting process. When ROI is used as a managerial performance measure, Measuring returns on invested capital also focuses managers’ attention on the impact of levels of working capital (in particular, stocks and debtors) on the ROI. It can lead to decisions making that are optimal for individual divisions but sub-optimal for the company. ROI focuses on short-term profitability, looking only at the last quarter or last year for performance evaluation. This time horizon may not be long enough for many projects to be evaluated.

(a) It is a comprehensive measure and captures all the factors which influence figures in financial statements.

(b) It is easy to calculate and understand.

(c) It makes comparison of performances of different divisions easy.

(d) Data on ROI of different companies are easily available and that helps in inter-firm comparison.