MEASURING AND

CONTROLLING ASSETS
EMPLOYED
Chapter 7
Adit Bima Estie Inge Hanif
Presented by:
INTRODUCTION
In some business unit, focus is on PROFIT. In other
business unit, profit is compared with the assets
employed.
In real world, companies call it Profit Center rather
than Investment Center
The latter is a special type of the former
Many problems involved in measuring the assets
employed in a profit center
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PURPOSE
1. Provide information useful in making sound
decision about assets employed and to
motivate managers to make these sound
decision in the best interest of the company
2. Measure the performance of the business
unit as an economic entity
Measuring Assets Employed
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PERFORMANCE OBJECTIVES
1. Generate profit from the resources at their
disposal
2. Invest in additional resources only when
investment will produce an adequate
return
The purpose of relating PROFIT to INVESTMENT motivate
business unit managers to accomplish these objectives
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RELATING PROFIT TO ASSETS
EMPLOYED
1. Return on Investment (ROI)
ROI is a ratio. The numerator is income, as reported on the
income statement. The denominator is assets employed.
2. Economic Value Added (EVA)
EVA is a dollar amount, rather than a ratio.
EVA = Net Operating Profit Capital Charge
This capital charge is found multiplying the amount of assets
employed by a rate.
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EVA v. ROI
EVA is conceptually superior to ROI.
However, it is clear from surveys
that ROI is more widely used in a
business rather than EVA.
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INVESTMENT BASE
1. What practice will induce business unit manager
to use their assets most efficiently and to
acquire the proper amount and kind of new
assets?
2. What practices best measure the performance
of the unit as an economic entity?
To decide which investment base to use, ask the following:
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1. CASH
Many companies use a formula to calculate
the cash to be included in the investment
base.
Some companies omit cash from the
investment base. These companies argue that
the amount of cash approximates the current
liabilities.
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2. RECEIVABLES
Business unit managers can influence the level of
receivables indirectly, by their ability to generate
sales, and directly by establishing credit terms and
approving individual credit account.
The usual practice is to include receivables at the
book amount, which is the selling price less an
amount for bad debts.
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3. INVENTORIES
Inventories ordinarily are treated similar
to receivables
recorded at end of period amount
although intra period averages would
be preferable conceptually.
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4. WORKING CAPITAL IN GENERAL
At one extreme, companies include all
current asset in the investment base
with no offset for any current liabilities.
At the other extreme, all current
liabilities may be deducted from
current assets.
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5. PROPERTY, PLANT,
AND EQUPMENT
If depreciable assets are included in the investment base
at net book value, business unit profitability is misstated.
The fluctuation in EVA & ROI from year to year can be
avoided by including depreciable assets in the investment
base at gross book value than net book value.
If depreciation is determined by the annuity, rather than
straight line method, the business unit profitability
calculation will show the correct EVA & ROI.
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6. LEASED ASSETS
The business unit managers are induced to
lease, rather than own, assets whenever the
interest charge that is built into the rental cost
is less than the capital charge that is applied to
the business units investment base, because it
would increase EVA.
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WHY ROI OVER EVA?
1. Comprehensive measure in that anything that
affects financial statements is reflected in this
ratio.
2. It is simple to calculate, easy to understand, and
meaningful sense.
3. It is a common denominator that may be applied
to any organizational unit responsible for
profitability, regardless of size or type of business.
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WHY EVA OVER ROI?
1. Profit objectives are consistent across all business units
2. Decisions that increase a centres ROI may decrease its overall
profits. If an investment centres performance is measured by
EVA, investments that produce a profit in excess of the cost of
capital will increase EVA and therefore be economically
attractive to the manager.
3. Different interest rate may be used for different types of
assets.
4. In contrast to ROI, EVA has a stronger positive correlation with
changes in a companys market value.
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EVA AND ROI
EVA = Net Profit Capital Charge

Where;

Capital Charge = Cost of Capital * Capital Employed

Another way to calculate EVA

EVA = Capital employed (ROI Cost of capital)
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HOW TO INCREASE EVA?
1. Increase in ROI through BPRE and productivity gain,
without increasing the asset base.
2. Divestment of asset, product and/or businesses whose
ROI is less than the cost of capital.
3. Aggressive new investment in assets, products, and/or
business whose ROI exceeds the cost of capital.
4. Increase in sales, profit margins or capital efficiency or
decrease in cost of capital percentage without affecting
the other variable in second equation.
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DELL COMPUTER CORP.
CASE STUDY
BACKGROUND
Founded by Michael Dell in his dorm room at the
University of Texas in 1984 with $1000
Company headquartered in Round Rock, Texas, U.S.A.
Worlds largest direct-selling computer company,
with 56,700 employees in >80 countries
By 2005, DELL was valued at more than $100 billion
#1 Retailer of PC, outselling IBM and HP
Uses direct selling as its key strategy
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BACKGROUND
In 2005, DELL was ranked as Americas most
admired company by Fortune, where 16.7% of
computers sold in the world was a DELL
machine
Financial performance:
Revenue growth was at 19% (or 7% higher
than industry average)
Net margins of 6% (while industry lagged at
1%)
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DELLs OBJECTIVES
1. A direct relationship: the most efficient path to the
customers;
2. Custom built products and custom-tailored service: the
most effective way to meet customer needs;
3. Standardised technologies: best value to customers;
4. Low-cost structure: cost savings passed to customers in
form of lower prices;
5. Deliver added value to customers: customers able to obtain
highest return on their investment in IT products and
services.
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BUILD-TO-STOCK PC VALUE CHAIN
Component
Manuf.
PC
Manufacturer
Distributor/
Reseller
Order
Product
Product
Forecast
Component
Components
MicroAge,
CompuCom
Corporate
Customer
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DELL DIRECT MODEL
Component
manufacturer
DELL Comp
Corp
Distributor
Final
Customer
Components
Order
Product
(build-to-order)
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DELL DIRECT MODEL
Dell Computers direct model departed from the industrys historical
rules on several fronts:
The company outsourced all components but performed assembly;
It eliminated retailers and shipped directly from its factories to end
customers;
It took customized orders for hardware and software over the phone
or via the Internet;
It designed an integrated supply chain linking Dells suppliers very
closely to its assembly factories and order-intake system.
(build-to-order)
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DELL HYBRID MODEL
Direct
sell
Retail
stores
Hybrid
business
model
To augment direct sale approach, DELL set up kiosks in
malls and planned a series of marketing campaigns
By November 2004, about 15% of DELLs revenues came
from consumer electronics business
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What is DELLs strategy? What is
the basis on which Dell builds its
competitive advantage?
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STRATEGY
Value Chain Re-engineering in the PC
Industry Based on trends in early 1980s:
Corporate customers getting sophisticated;
did not require personal selling
Different components of a PC became
standard modules mass customization
Q1
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STRATEGY
DELLs strategy is a
combination of:
Direct Sales
Inventory Management
Supplier Integration
Maximum Effectiveness Minimum Cost
Always
listen to
Customers
Never Sell
Indirect
Disdain
inventory
Q1
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STRATEGY
Result of DELLs Value Chain Re-
engineering:
Revenue growth was at 19% (or
7% higher than industry average)
Net margins of 6% (while
industry lagged at 1%)
Q1
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COMPETITIVE ADVANTAGE
Direct model success
Technology and IT
Short delivery time
Affordable prices
Superior customer service
Expansion into new products
Customer-driven Research and Development
Integrated Supply Chain
Q1
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How do DELL control systems
help execute the firms strategy?
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FINANCIAL MEASURES
Return on Invested Capital
Average Selling Price
Component Purchasing Cost
Selling and Administration
Cost and Margins
Q2
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NON-FINANCIAL MEASURES
Component
inventory
Finished goods
inventory
A/R Days
A/P Days
Cash Conversion
Cycle
Stock outs
Accuracy of
Forecast Demand
Q2
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THANK YOU!
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Q2