ABSTRACT: Every investment activity involves higher degree of risk than investment in bank savings accounts or government bonds. But the investor of the business expects a high degree of return as he assumes high degree of risk. The source of the return is the profit earned from the operations of the business. Therefore, the corporate shareholder tends to judge corporate management according to the amount of profit earned relative to the capital the shareholders have provided. This paper suggests the techniques for judging the performance of the corporate management to take further decisions. INTRODUCTION: Investing wisely is an important part of financial security. Everybody will try to start invest money as early as possible so that the money will grow accordingly in their lifetime. Choosing a wise investment is very crucial because they have to balance the risks and returns. For example many people invest private firms which offer very high interest rate but they may vanish after some time loosing all the invested money. Today Indian youths are well paid compared to last decades thanks to Information Technology, ITES like BPO, Call Center and overall strong economy. So people are able to save more money and they are ready to take risk also. Young investors have started to invest in shares due to their high disposable income, easy to make money, diversify their investment, attractive return, etc. But investment in shares involves much risk like business risk, financial risk, political risk, market risk, interest risk etc of the company. So before investing in shares the investors need to judge about the performance of the corporate. Return on capital has come in for considerable attention in recent years as an effective tool for appraising management performance. Here the importance of a simple ratio - return on capital as a device for appraising management performance is demonstrated by examining the following. 1. Investors ratio
2. The ratio of earnings to capital used
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Investor's ratio: It refers to the return on common shareholders equity. It measures the relationship between the net income after taxes and shareholders equity, which can be calculated by dividing the former with the later. It is calculated based on the historical data and not subject to direct influence from the stock market changes. It can be used as a predictor of corporate failure. The ratio of earnings to capital used: It refers to the return on ROI, return on assets used, or return on capital employed. It is calculated by dividing the income from operations by the total operating assets. It is used to depict the effectiveness of all the operating decisions from the routine to the critical, made by management at all levels of the corporate from shop supervisor to president. For example:
Production Decisions:
Marketing decisions
Administrative decisions Application of return on capital used. : The purpose for which Return on capital is calculated affects the type and valuation of factors making up operating assets and operating income. If the purpose is to measure the performance of the company as a whole, the problem is different from that of measuring the performance of company segments. The return on capital is used to evaluate the performance of operating management in segments of a company, such as product divisions, branch plants, sales territories, capital expenditure decisions, pricing, decisions among alternative choices and the like.. Problem of using return on capital used: A true measurement of efficiency in the use of capital resources cannot be done using capital employed as defined in a company's balance sheet. This is because the balance sheet capital employed is a static measure of capital employed at a date and not for the entire period. Hence, the result to be obtained from such measurement would invariably be influenced by the static nature of the value of capital employed as at that date. More so, such a measure will produce a larger than life result as the capital employed at balance sheet date will always tend towards producing an average rather than the total resources employed. Also, when a firm has negative net worth, the return on capital used produced will be totally distorted and basically meaningless. Conclusion: There is much similarity in the use of the return on capital concept as applied to the evaluation of an investment- a financial purpose and its use in measuring managerial effectiveness. Return on capital used or residual income is regarded as a good devices, along with the number of others, for both motivating and measuring the performance of segment management. At the same time their limitations and pitfalls must be borne in mind. The danger of faulty measurement and negative motivation can be minimized by adopting the approach of reporting of return on capital used and residual income for the segment manager in terms only of changes in his or her own segment over a period of time, so that unfair comparisons with other segments of the company can bee avoided. S. Anitha M.com., M.phil. (Ph.d) |
