ROCE / ROI by amilamadhushan

VIEWS: 655 PAGES: 15

More Info
									1
What is ROCE?
Return On Capital Employed

 ROCE compares earnings with capital invested in
 the company



                 Operating Profit
 ROCE =                                X 100%
                Capital Employed


                                                   2
Importance of ROCE
 Performance Appraisal Purpose
 Compare Performance of different divisions
 Calculate profitability of undertaking a project
 Set targets




                                                     3
Problems of ROCE
 ROCE does not have an unique definition

 Possibility of manipulating ROCE during transactions

 Selling assets to increase ROCE

 Divisional manager will invest in a project only if the

 incremental ROCE is more than the current ROCE

 Continuation of old assets – not going for new assets

 Cut down discretionary costs

                                                            4
Discretionary Costs
Cost that a manager may eliminate or postpone without
disrupting the firm's operations or affecting its
productive capacity in the short run.

E.g. :
    • advertising
    • preventive maintenance
    • research and development

Sometimes these are called as managed costs.
                                                        5
Case Study



             6
• Turkey Airline management rewards divisional managers
  based on ROCE reported.
• Currently the management is evaluating last year’s
  performance.
• Manager in charge for Europe was given a ROCE target of
  15% to be achieved in 2006. He achieved this target with
  a reported ROCE of 15.3%.
• Turkey management is implementing a bottom up
  approach to budgeting.
• It was pointed out that industry will be affected due to,
        Recession in world economy
        Possible increase in oil price
• In a total fleet of 20 aircrafts,7 of them were due for
  replacement in any time over the next 2 years.              7
Cutting down Discretionary Costs
  The security in the Airline industry should be
   100%. So the preventive maintenance should be
   done regularly.
  Yet, the manager in Europe could cut down
   preventive maintenance costs, in-flight services
   etc. considering them as discretionary costs.
  Because of this the current ROCE will increase,
   but the organization will be affected in the long-
   run.


                                                        8
 Because the operation of the industry has affected by
  recession and increasing oil prices, the chance of
  eliminating discretionary costs are higher

 It is a fact that planes are often crashed in recession
  times




                                                            9
Fuel Price Increase
 The case study shows that the fuel prices were rising
 The Turkey airline plane crashed on 25 Feb 2009 was
 suspected to be due to unavailability of fuel.




                                                          10
Implementation of Bottom Up
Approach to Budgeting
 Bottom up approach is considered good in most of the
 cases. But it has problems as well.

 The divisional manager might have influenced a lower
 ROCE target. In normal operational conditions he may
 have reported a higher ROCE



                                                         11
Replacement
 7 air crafts should be replaced, which will decrease
  ROCE.

 But the replacement is essential for the safety of the
  passengers.

 Divisional manager may not do so since the
  replacement will increase his capital employed.


                                                           12
Paying bonus on ROCE?
 Divisional manager can manipulate ROCE


 Manipulation may cause harm to the group
 management’s objectives

 Payment of bonus on ROCE is not advisable




                                              13
Solutions
 Using a variety of measures to evaluate the
 performance

 The group management can use non financial
 performance indicators as well

 Group management can adopt a flexible evaluating
 system


                                                     14
15

								
To top