Divisional Performance Measurement

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1 Introduction

The previous chapters have concentrated on ways of measuring the performance of a business.

Many businesses are divisionalised in that there are separate managers responsible for separate parts (or divisions) of the business, and it is important to be able to measure the performance of individual divisions and of their managers.

Non-financial measures are just as important as for the whole business, but it is with regard to the financial performance that we need to give a little more thought. It would be misleading to compare divisions simply on their final profits in that larger divisions would be expected to report higher profits without necessarily being managed better. It is therefore important that the profitability is related to the size of the division.

You should be aware of two ways of measuring the profitability of a division – the return on investment (ROI) and the residual income (RI) – and these will be explained in the following paragraphs.

2 Return on Investment (ROI)

Perhaps the most obvious way of measuring the profitability of a division is to express the profit as a percentage of the amount invested in the division.

3 Residual Income (RI)

This measure is a little less obvious.

We take the profit of the division, and subtract from it notional (or ‚pretend‘) interest of a target rate applied to the net assets from the Statement of Financial Position.

4 Advantages and limitations of ROI and RI