Accounting Business Reporting for Decision Making

CHAPTER 14 Performance measurement 575

Return on investment for a division

The formula for return on investment (ROI) is:

Return on investment (ROI) =

Profit

Divisional investment

In our example, the ROI for each of the three divisions would be as follows.

Corporate Department stores Specialty stores

ROI =

Divisional margin

Divisional investment

=

$400 000

$2 200 000

=

($70 000)

$75 000

=

$70 000

$225 000

= 18.2% = (93.3%) = 31.1%

The above indicates that the specialty stores division is performing better than the corporate or
department stores division relative to the level of investment. An entity’s desired ROI level will depend
on the type of industry the entity operates within, the current economic conditions and the current life-
cycle phase of each division.
Further analysis of the ROI can be conducted using the Du Pont ROI, which is the return on sales
multiplied by the investment turnover for divisions. This formula was used at the Du Pont Corporation
in the early 1900s to conduct divisional evaluations. It is also referred to as the Du Pont Method or the

Du Pont Formula.

Du Pont ROI = Profit margin × Investment turnover

Profit

=

Profit

×

Sales

Investment Sales Investment

Applying this formula to each of our divisions would give the following.

ROI = Return on sales × Investment turnover

Corporate $400 000

$2 200 000

=

$400 000

$990 000

×

$990 000

$2 200 000

18.2% = 40.4% × 0.45 times

Department stores ($70 000)

$75 000

=

($70 000)

$400 000

×

$400 000

$75 000

• 93.3% = –17.5% × 5.3 times
  Specialty stores $70 000
  $225 000

=

$70 000

$520 000

×

$520 000

$225 000

31.1% = 13.46% × 2.31 times

The above calculations show that the corporate division has an investment turnover of 0.45 times.
Investment turnover, sometimes called asset turnover is a ratio that measures the amount of sales gen-
erated relative to the level of investment. This means that every dollar invested in the corporate division
has generated $0.45 in revenue. The profit margin, sometimes referred to as the return on sales, is a ratio
that measures profit relative to sales for a division. The profit margin of 40.4 per cent indicates that every
sales dollar acquired by the corporate division has turned into $0.404 in divisional profit. Overall, the cor-
porate division has a higher profit margin but a lower asset turnover than the other divisions.
Compare the ratios presented above (ROI, profit margin and asset turnover) to the formulas for return
on assets (ROA), profit margin and asset turnover presented in chapter 8. Note the similarity and the
differences. In chapter 8, profit is defined as ‘after-tax profit’. The formulas presented in this chapter are
quite general and show that the concept can be specifically adjusted to suit financial statement analysis
(as was the case in chapter 8) or to divisions or segments.
The asset turnover of the department store division is 5.3 times. This indicates that it generated $5.30
in sales for every dollar invested, which is good relative to the other divisions. However, its return on
sales is poor, indicating that it cannot turn these sales into profit. It needs to increase selling prices and/
or control variable costs more tightly. In the longer term, fixed costs should be scrutinised.