Divisional Performance Measurement

Detailed Definition

Divisional Performance Measurement refers to how the central management of an organization evaluates the performance of its individual divisions within a divisionalized structure. The goal of these measurements is to assess how well each division is performing and contributing to the overall success of the company. It allows management to make strategic decisions, allocate resources effectively, and incentivize divisional managers to align their activities with the broader organizational objectives.

Methods of Divisional Performance Measurement

1. Return on Capital Employed (ROCE):

   • Definition: ROCE is a financial performance ratio that measures a company’s profitability and the efficiency with which its capital is employed. The formula is: \[ \text{ROCE} = \frac{\text{Operating Profit}}{\text{Capital Employed}} \times 100 \]
   • Example: If a division has an operating profit of $1,000,000 and capital employed of $5,000,000, the ROCE is: \[ \text{ROCE} = \frac{1,000,000}{5,000,000} \times 100 = 20% \]

2. Residual Income (RI):

   • Definition: RI represents the net operating income earned above the minimum required return on a company’s assets. The formula is: \[ \text{RI} = \text{Operating Income} - (\text{Capital Employed} \times \text{Minimum Required Return}) \]
   • Example: For a division with an operating income of $500,000, capital employed of $2,000,000, and a required return of 10%, the RI is: \[ \text{RI} = 500,000 - (2,000,000 \times 0.10) = 300,000 \]

3. Profit-to-Sales Ratio:

   • Definition: This ratio assesses the relationship between the division’s profits and its sales. It is helpful in understanding the profitability of sales activities. The formula is: \[ \text{Profit-to-Sales Ratio} = \frac{\text{Net Profit}}{\text{Net Sales}} \times 100 \]
   • Example: If a division has a net profit of $200,000 and net sales of $1,000,000, the ratio is: \[ \text{Profit-to-Sales Ratio} = \frac{200,000}{1,000,000} \times 100 = 20% \]

Examples

1. Example 1: Retail Division

   • A retail division of a corporation employs $10 million in capital and earns an operating profit of $2 million. The ROCE for this division is: \[ \text{ROCE} = \frac{2,000,000}{10,000,000} \times 100 = 20% \]

2. Example 2: Manufacturing Division

   • A manufacturing division generates a net operating income of $3 million and employs a capital of $8 million with a minimum required return of 15%. The RI is: \[ \text{RI} = 3,000,000 - (8,000,000 \times 0.15) = 1,800,000 \]

Frequently Asked Questions

1. What is the importance of Divisional Performance Measurement?

• Divisional performance measurement is crucial for decentralizing control and empowering divisional managers, improving decision-making, aligning divisional goals with corporate objectives, and enhancing overall organizational performance.

2. How is ROCE different from Residual Income?

• ROCE measures the percentage return on capital employed across all divisions, focusing on overall efficiency and profitability. Residual Income, on the other hand, assesses the actual dollars of income remaining after accounting for the cost of capital, providing a clearer picture of value creation.

3. Can Profit-to-Sales Ratio be used for performance comparison?

• Yes, the Profit-to-Sales Ratio allows for comparative analysis across different time periods and different divisions, highlighting changes in profitability due to variations in sales and cost efficiencies.

Related Terms

1. Performance Measurement:

   • The process of evaluating the efficiency and effectiveness of an action or performance. It involves the systematic collation, analysis, and reporting of information regarding the performance of individuals, teams, or organizations.

2. Balanced Scorecard:

   • A strategic planning and management system used extensively in business and industry, government, and nonprofit organizations to align business activities to the vision and strategy of the organization, improve internal and external communications, and monitor organizational performance against strategic goals.

3. Benchmarking:

   • The practice of comparing business processes and performance metrics to industry bests and best practices from other companies to set standards for improvement.

Online References

• Harvard Business Review: The Balanced Scorecard—Measures that Drive Performance
• AccountingTools: ROCE

Suggested Books for Further Studies

1. Performance Measurement and Control Systems for Implementing Strategy by Robert Simons
2. Managerial Accounting: Tools for Business Decision Making by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
3. Accounting for Decision Making and Control by Jerold L. Zimmerman
4. The Balanced Scorecard: Translating Strategy into Action by Robert S. Kaplan and David P. Norton

Accounting Basics: “Divisional Performance Measurement” Fundamentals Quiz

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