An investment center is a subunit of an organization that has control over revenues, costs, and certain assets. Evaluating the performance of an investment center can be done through certain metrics.
1. Return on Investment (ROI) - measures the degree of profitability by dividing income over investment.
ROI = (Income / Investment) x 100%
2. Residual Income (RI) - represents the excess of income earned from the desired or target income.
Residual Income = Operating income - Desired income
3. Economic Value Added (EVA) - a more precise version of residual income that considers after-tax operating income, weighted average cost of capital, and current obligations.
EVA = After-tax operating income - Desired income
4. Market Value Added (MVA) - measures the difference between the market value of the firm and the book value of the invested capital.
MVA = Market value of stocks - Book value of stockholders' equity
5. Equity Spread - calculates the value creation of equity.
ES = Beginning stockholders' equity x (return on equity - cost of equity)
6. Total Shareholders' Return (TSR) - calculates the combined return from change in stock price and dividends.
TSR = [(Capital gains + Current income) / Initial price of stock] x 100%
7. Manufacturing Cycle Time - or throughput time, is the time required to convert materials into finished goods.
MCT = Process time + Move time + Inspection time + Queue time
8. Manufacturing Cycle Efficiency - measures how much of manufacturing cycle time is devoted to value-adding activities.
MCE = (Process Time / Manufacturing Cycle Time) x 100%
In addition to the above measures, the company may also adopt the concepts of balanced scorecard. Balanced scorecard takes a look at four major components (known as lenses) that affect the achievement of organizational goals and implementation of strategy.
These lenses are: (1) financial perspective, (2) customer perspective, (3) internal business process perspective, and (4) learning and growth perspective.
Two of most widely used tools used in evaluating investment centers are: return on investment (ROI) and residual income (RI). Aside from the ROI and RI, there are other performance measures that can be used.
Other evaluation metrics include: economic value added (EVA), market value added (MVA), equity spread, total shareholders' return, and the manufacturing cycle efficiency. You will learn all about them in this lesson.