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CFO Fundamentals: Your Quick Guide to Internal Controls, Financial Reporting, IFRS, Web 2.0, Cloud Computing, and More by ALLISON I. SHIM, JOEL G. SIEGEL, JAE K. SHIM

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CHAPTER EIGHTEEN

How to Analyze and Improve Corporate Profitability and Shareholder Value

MEASURES OF MANAGERIAL PERFORMANCE AND SHAREHOLDER RETURN

How do you measure managerial performance and the return to stockholders?

The ability to measure performance is essential in developing incentives and controlling operations toward the achievement of organizational goals. Perhaps the most widely used single measure of profitability of an organization is the rate of return on investment (ROI). Related is the return to stockholders, known as the return on equity (ROE).

An alternative measure that gained huge popularity is Economic Value Added (EVA). A problem with just assessing performance with financial measures like ROI, ROE, and EVA is that the financial measures are backward looking. In other words, today’s financial measures tell you about the accomplishments and failures of the past. An approach to performance measurement that also focuses on what managers are doing today to create future shareholder value is the balanced scorecard.

What is return on investment?

ROI relates net income to invested capital (total assets). It provides a standard for evaluating how efficiently management employs the average dollar invested in a firm’s assets, whether that dollar came from owners or creditors. Furthermore, a better ROI can also translate directly into a higher return on the stockholders’ equity. ROI is calculated as:

Example 18.1

Consider the following financial data:

Then

The ...

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