Question

22. How is return on investment calculated and how it is used? Investment turnover? Profit Margin? Residual income?

23. What is meant by centralized vs. decentralized organization?

24. What is the difference between controllable and uncontrollable costs?

Answer 1

Ans 22

RETURN ON INVESTMENT HOW IT IS CALCULATED AND USED:

Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. ROI tries to directly measure the amount of return on a particular investment, relative to the investment’s cost. To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment. The result is expressed as a percentage or a ratio.

ROI is a popular metric because of its versatility and simplicity. Essentially, ROI can be used as a rudimentary gauge of an investment’s profitability. This could be the ROI on a stock investment, the ROI a company expects on expanding a factory, or the ROI generated in a real estate transaction. The calculation itself is not too complicated, and it is relatively easy to interpret for its wide range of applications. If an investment’s ROI is net positive, it is probably worthwhile. But if other opportunities with higher ROIs are available, these signals can help investors eliminate or select the best options. Likewise, investors should avoid negative ROI’s, which imply a net loss.

It can be calculated using this formula

​ROI=(Current Value of Investment−Cost of Investment​​)/cost of investment

INVESTMENT TURNOVER RATIO

1. A variety of metrics are available today that allow individuals to effectively assess and measure the performance of a business relative to industry-wide benchmarks.

2. This type of comparison can be particularly helpful in situations where an investor may be seeking to determine whether or not a particular company represents a credible investment or falls behind in a number of important areas.

3. An investment turnover ratio is one such metric that analyzes the capacity of a company to generate revenue given a specific amount of funding. Calculating the investment turnover ratio of a company can be accomplished using net sales data, as well as stockholder equity and current outstanding debt

FORMULA

You can calculate the investment turnover ratio of a company by dividing the net sales value by the sum of shareholder equity and outstanding debt. The resulting number is the current investment turnover ratio of the company in question.

Broadly defined, the investment turnover ratio of a company is the resulting number value when net sales are divided by the sum of shareholder equity and outstanding debt. Whatever the final number may be, this represents the specific number of revenue multiples that could potentially be generated given the stated amount of funding

It is important to keep in mind that the investment turnover ratio is largely distinct from other popular metrics, such as the investment-to-sales ratio. Perhaps the most important consideration regarding the investment turnover ratio is that this particular calculation is not directly related to profit in any way. For example, it is entirely within the realm of possibility that a company could have an extremely high investment turnover ratio and still be recording losses from daily operations.

Yet another important consideration regarding the investment turnover ratio is the idea that adding additional funds may not necessarily result in an increased or even identical rate of turnover. This type of stagnation could occur when market conditions have reached a saturation point and business leaders are reaping significantly reduced return on invested funds.

Although the investment turnover ratio does provide insightful metrics for investors, it is also important to remember that the specific level of investment required in order to achieve returns varies considerably among different industries. For example, some businesses require an extremely large pool of fixed assets in order to commence operations, while others may not need any at all.

With that in mind, investors should act carefully when drawing comparisons between companies existing in different sectors of the economy, as the intrinsic nature of these organizations may invalidate any conclusions drawn through the use of the ratio formula. This same rule applies to investors applying other similar formulaic evaluations, such as the asset turnover ratio.

PROFIT MARGIN ;

Profit margin is one of the commonly used Pprofitability ratio to gauge the degree to which a company or a business activity makes money. It represents what percentage of sales has turned into profits. Simply put, the percentage figure indicates how many cents of profit the business has generated for each dollar of sale. For instance, if a business reports that it achieved a 25% profit margin during the last quarter, it means that it had a net income of $0.25 for each dollar of sales generated.

There are four levels of profit or profit margins:

1. gross profit,

GROSS PROFIT MARGIN=(NET SALES – COGS)/NET SALES​

WHERE:COGS=COST OF GOODS SOLD​

2. operating profit,

OPERATING PROFIT MARGIN= (OPERATING INCEOME /REVENE)*100

3. pre-tax profit,

PRE TAX PROFIT MARGIN

Take operating income and subtract interest expense while adding any interest income, adjust for non-recurring items like gains or losses from discontinued operations, and you’ve got pre-tax profit, or earnings before taxes (EBT); then divide by revenue, and you've got the pretax profit margin.

4. net profit.

NET PROFIT MARGIN=

These are reflected on a company's income statement in the following sequence: A company takes in sales revenue, then pays direct costs of the product of service. What’s left is gross margin. Then it pays indirect costs like company headquarters, advertising, and R&D. What’s left is operating margin. Then it pays interest on debt and adds or subtracts any unusual charges or inflows unrelated to the company’s main business with pre-tax margin left over. Then it pays taxes, leaving the net margin, also known as net income, which is the very bottom line.

RESIDUAL INCOME

1. Residual income is excess income generated more than the minimum rate of return.

2. Residual income is a measurement of internal corporate performance, whereby a company's management team evaluates the income generated relative to the company's minimum required return.

3. However, in personal finance, residual income is the level of income an individual has after the deduction of all personal debts and expenses paid.

COMPUATION OF RESIDUAL IMCOEM IS AS FOLLOWS

Residual income = operating income - (minimum required return x operating assets).

ANS 23.

CENTRALIZED ORGANISATION

A centralized organization is one where core important decisions are taken by those at a higher level of authority. All important decisions are routed through this channel and are taken by those who are in a position to look at things from a broader perspective and have gained a lot of knowledge and experience over the years. After the decision is taken, it is communicated to the lower level employees who are expected to follow the orders.

This kind of a structure depends heavily on certain key people to conceptualize and implement certain key decisions. This needn’t mean that there is just one person making all the decisions in the organization. People at different levels are authorized but, unlike decentralized organizations, there is less team based decision making and more of individual decision making.

DECENTRALIZED ORGANISATION

A decentralized organization, as the name suggests, is one where the decision making authority is not solely in the hands of a particular group or figure but with multiple people at multiple levels of the hierarchy.

In this type of an organization, most of the decisions are made by middle level or lower level employees rather than being made by the top management, as is the case with centralized organizations.

KEY DIFFERENCES

· In a centralized organization, there is a presence of vertical flow of information. The orders come from the senior management and follows a top to bottom approach and the junior and middle management report to the seniors thereby creating a down to up flow of information.

· In a decentralized organization, there is vertical and horizontal flow of information. Senior management, middle management and the junior management are all connected to each other. There is also free flow of information between employees in a particular level of management

· Centralized organizations are best fit for companies of a smaller size. The central figure of authority is then able to make better and more well informed decisions. This is also fit for boutique consulting firms etc.

· A decentralized model is best suited for huge multinationals that operate in many countries and have diversified employees to manage and varied rules and regulations to adhere to.

· The environment of a company and is sustenance is mostly stable in centralized organisations since the decisions are taken by a central authority which are consistent with each other.

· A decentralized organization is more prone to instability and uncertainty. Decisions taken in a decentralized organization are not always in sync because they are taken by different centres of power that do not always think and act alike. There is also a lot of scope for personal bias to creep in, in decentralized organizations since employees can put their personal interest before that of an organization.

· Middle & lower management in a centralized company are not used to decision making and would rather be decision followers rather than decision makers.

· Middle and lower management are more skilled and equipped at decision making in a decentralized organization because they have the experience of decision making. They are also more innovative and can think out of the box. The scenario is not the same in a centralised organization.

· The main outcome or objective of a centralized organization is that the whole burden falls on the shoulders of a particular body.

· The objective of a decentralized system is that the burden is shared

ANS.NO 24

Differences between Controllable and Uncontrollable Cost

IN TERMS OF DEFINITION

Controllable cost refers to a cost that can be altered based on a business decision or need. On the other hand, uncontrollable cost refers to a cost that cannot be altered based on a personal business decision or need.

INTERMS OF TIME SPAN

While controllable costs can be altered in the short run, uncontrollable costs can be altered in the long run.

IN TERMS OF EXAMPLES

An example of controllable cost includes direct labor, direct materials, donations, training costs, bonuses, subscriptions and sues, and overhead costs. On the other hand, an example of uncontrollable costs includes depreciation, insurance, administrative overhead allocated and rent allocated