Return on Investment (ROI) and Balanced Scorecard:

Simply exhorting managers to increase return on investment (ROI) is not sufficient. Managers who are told to increase return on investment (ROI) will naturedly wonder how this is to be accomplished.

Generally speaking, ROI can be increased by increasing sales, decreasing costs, and/or decreasing investments in operating assets. However it may not be obvious to managers how they are supposed to increase sales, decrease costs, and decrease investments in a way that is consistent with the company’s strategy. For example, a manager who is given inadequate guidance may cut back on investments that are critical to implementing the company’s strategy. For this reason when managers are evaluated on ROI, a balanced scorecard approach is advised. And indeed, ROI, or residual income, is typically included as one of the financial performance measures on a company’s balanced scorecard. The balanced scorecard provides a way of communicating a company’s strategy to managers throughout the organization. The scorecard indicates how the company intends to improve its financial performance. A well constructed balanced scorecard should answer questions like: “What internal business processes should be improved?” and “which customer should be targeted and how will they be attracted and retained at a profit?” In short, a well constructed balanced scorecard can provide managers with a road map that indicates how the company intends to increase  its return on investment (ROI). In the absence of such a road map of the company’s strategy, managers may have difficulty understanding what they are supposed to do to increase ROI and they may work at cross-purposes rather than in harmony with the overall strategy of the company.

You may also be interested in other articles from “decentralization, segment reporting and transfer pricing” chapter:

1. Decentralization in organizations
2. Traceable and common fixed costs
3. Segment reporting and profitability analysis-segmented income statements
4. Hindrances/Problems to Proper Cost Assignment in Segmented Reporting
5. Segmented Financial Information on External Reports
6. Return on Investment (ROI) for Measuring Managerial Performance
7. Controlling and Improving Rate of Return on Investment
8. Return on Investment (ROI) and Balanced Scorecard
9. Criticism, Disadvantages or Limitations of Return on Investment (ROI)
10. Residual Income-Another Method to Measure Managerial Performance
11. Limitations, Criticism or Disadvantage of Residual Income Method
12. Allow the managers involved in the transfer to negotiate their own transfer price (negotiated transfer pricing).
13. Set transfer prices at cost using variable or full (absorption) cost
14. Set transfer prices at the market price
15. Divisional Autonomy and Sub optimization
16. International Aspects of Transfer Pricing

Other Related Accounting Articles:

• Criticism/Disadvantages or Limitations of Return on Investment (ROI) Method of Performance Evaluation
• Limitations, Criticism or Disadvantage of Residual Income Method
• Residual Income-A Method to Measure Managerial Performance
• Transfer at Cost to the Selling Division
• Set Transfer Price at Market Price
• International Aspects of Transfer Pricing
• Methods of Controlling and Improving the Rate of Return on Investment (ROI)
• Segmented Financial Information on External Reports
• Return on Investment (ROI) Method for Measuring Managerial Performance
• Negotiated Transfer Pricing