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Organizations use a number of indexes to evaluate their annual financial performance. One of the most commonly used measures is the operating leverage that helps explain the responsiveness of operating income to change in sales. The best way to understand the concept is by looking at a real example. In the fiscal year ended on Sep. 27, 2014, for instance, Apple Inc. recorded an operating leverage of 1.1 times (calculations shown in excel). The implication of the index is that a 10% rise in sale during the next time period is likely to increase the operating income by 1.1%. Conversely, a 10% sales decrease in the next fiscal year will lead to a reduction in operating income by 1.1%.
On the other hand, the return on investment (ROI), also referred to as rate of return, is a popular performance evaluation metric that helps assess an organization’s success in terms of the earnings generated in a particular time period relative to the initial investment. Apple Inc.’s ROI for the period ended on Sep. 27, 2014 was approximately 8.8%. The implication is that the investors expect to earn a rate of 8.8% from their investment in the company. This is a high rate considering that it is above the free interest rate. However, there is a need to evaluate whether there exist other investment opportunities that promise a superior rate. An investor intending to commit his/her funds in the company will need to explore other available growth opportunities in the market. If there are such investment opportunities, it is prudent to choose the ones that promise the highest returns.
The economic value added (EVA) is also an ideal performance evaluation metric that can help estimate Apple Inc.’s investment for the period ended on Sep. 27, 2014. It is a useful tool that tells us the amount generated by an organization above the actual cost of equity. Its key purpose is to measure whether the management is creating value beyond the expected rate (Daft 2010). In case of Apple Inc., the company recorded an estimated EVA of $38,418,000 in its last reporting period. It is a positive figure implying that the firm’s management generated a higher return on invested capital than the cost of capital.
In addition, the market value added (MVA) is also a vital financial measure that is basically the spread between an organization’s fair value and the capital invested. In particular, the index denotes the excess value created by an organization beyond the actual resources committed in form of capital. In the fiscal year ended on Sep. 27, 2014, Apple Inc. recorded MVA of approximately $474,614,000. This implies that the organization’s market value was very high compared to the invested capital. It is a good indication that shows the company is creating more value than other firms operating on the market.
The abovementioned financial measures present a number of advantages and disadvantages. One of the chief advantages is that they are relatively easy to compute and interpret. Most of them do not require sophisticated computations. Moreover, they provide good ground for comparing performance between different time periods or/and organizations. The predominant demerit of the metrics is that they do not account for time value of money. Most of them make use of nominal values, which are highly prone to inaccuracies. In addition, they all use historical data that are also vulnerable to biasness.
References
Daft, R. L. (2010). Management. Mason, Ohio: South-Western Cengage Learning.
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