Control Through Return on Investment

The rate of return on capital is sometimes regarded as the ultimate test of business success. It is calculated as follows:

            Rate of Return   =             NET PROFIT           X 100%

                                    AVERAGE CAPITAL EMPLOYED

Accounting technicalities make this a notoriously unreliable figure.

ROI is a good control device where decentralization is encouraged due to its comparative equality. Furthermore it is complete and shows all the factors bearing upon the return. Like profits and loss ROI focuses managerial attention on a central measure of business success and therefore measures the efficiency of the company as a whole by emphasizing on making the best profits possible on the capital available.

However there is no general agreement on what constitutes a reasonable return on what the optimum rate should be. It could also lead to undesirable inflexibility in investing capital for more ventures because most companies fixed a minimum rate that must be met before allocation of capital. It is not foolproof, difficulties involve availability of information on sales, costs and assets or even proper allocation of investment.