To; The Board of Director

From; Management Accountant

Date; 17^th November 2009

Subject; Return on Investment as a Measurement of Managers and Divisional Performance

1.0)      Introduction

Management accounting deals with the provision of accounting information to be used to give managers in an organisation more information to help them make better decisions making and control (Lucey, 2003). Management accounting is different from financial accounting in that management accounting is produced to provide information for internal used only (managers) while financial accounting is produced to provide information for external use (Lucey, 2003).The main aim of gathering management accounting information is;

• Helping in effective decision making
• Helping in supporting information for financial report
• Assisting in formulating strategies for an organisation as a whole
• Forecasting, Planning and control of business activities
• Making sure resources are well utilised or optimised to reduce waste
• Setting budgets for the organisation

This report is aimed at;

• Calculating and evaluation ROI on Divisions P and Q as a method of measuring divisional managerial performance
• Recommending and illustrating other methods of performance evaluation

2.0)      Findings

2.1)       ROI

Return on investment (ROI) is part of the financial ratio and explains how much percentage of net income is derived from total assets invested in the company or division. This is also known as return on assets and describes how much is made as profit from a £1 of total assets invested in the company. It is calculated by dividing net income over total assets

Net profit × 100

Total assets

From the calculations presented in the table above, it can be seen that from 2006 to 2008, Mr Aye has constantly managed Division P well by increasing their return on investment from 3% to 14%. In 2008, the division almost tripled it ROI compared to that of the previous year to 14%. However, My Aye has not yet met the 20% expected annual rate of return for the division that was set by the company.

On the other hand, Mr. Bee of Division Q met the expected rate of return in his second year. In Mr. Bee’s first year, his ROI was lower than the expected annual ROI of 16%. In his second year, he went pass the company’s expectations by generating an annual ROI of 17.5% and 28.6% in 2008. Despite a fall in total assets, the division managed to make more profits in 2008 which greatly affected its ROI. This may imply Mr. Bee is making maximum use of its assets and therefore reducing waste in resources.

From the above table and explanation, it could be concluded that Mr. Bee is doing a better job than Mr. Aye. What should be considered in this scenario is that, Division P is a new division that has just been created and is still growing while Division Q has been operating for the past 20 years. Every new business incurs high costs in its first years of operations. Both Managers are working very hard towards achieving the estimated ROI per annum.

2.2)       Other Methods of Performance Evaluation

There are different ways that the company can use to evaluate the performances of both divisional managers. These ways are mostly looking at the behaviours of managers and their communication with employees and stake holders.

2.2.1) Management by Objective

This is a method of performance evaluation for divisional managers where the company sets objectives for the divisional managers and make sure that they understand and work towards the objectives (Drucker, 1954). This allows the main management to set goals and plans of action for the divisional managers to follow and the divisional managers are then evaluated by comparing their actual result with that of the original plan (Drucker, 1954). ROI could be part of management by objective but it is not the only factor for this type of performance evaluation. This can also include achieving a certain market share, profit level, growth level and new product. This type of performance evaluation gives managers the ability to work efficiently with a plan of action and create a better communication between the company and the divisional manager

2.2.2) Critical Incident

This is a method that looks at the effective and ineffective behaviour about the divisional managers and how they relate to their employees (Flangan, 1954). This is used to analyse manager behaviour at work and how they interact with their employees and stakeholders. This means managers who have ineffective behaviour carry out poor communication and bad behaviour towards their employees which can be an obstacle to work efficiency. The manager’s behaviour can either encourage the employees to be more productive or discourage them. This may affect sales because employees will not be happy working in such an environment. On the other hand, efficient behaviour from managers encourages employees to work harder and towards achieving the company’s goals. Critical incident is very important to carry out in order to identify communication and behavioural problems. The problem of ineffective behaviour can be solved by having a one on one discussion with the managers. This one on one discussion is also useful when the cause of a problem is not well defined so the company can find out what is going on in the division.

Conclusions and recommendations

Evaluating the performance of both divisional managers is very important for the company because it tells them if it is worth extending their contract or not. On the other hand, using just one method of evaluation is not a good way to come to a conclusion. Financial results are not always the only methods of performance evaluation. The companies should also use other methods like critical incident and management by objective. This will always give an evaluation of behaviour of managers, which is very important for communication and achieving goals.

References

• Drucker, Peter (1954). The practice of management. New York, Harper and Rows
• Flangan, John (1954) Psychological Bulletin; The critical incident technique. University of Pittsburg. Vol 51, No. 4

• Lucey Terence (2003). Management Accounting. 5^th Cengage Learning EMEA, 2003