Financial Analysis

Performance Measures and Transfer Pricing

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Performance Measures and Transfer Pricing

Introduction

It is important for every organization to evaluate the performance of its operations. ROI (Return on Investment) and Economic Value Added (EVA) are two of the most common performance measures used in the corporate world. Despite the popularity of these measures, it is important to emphasize that both these performance measures compel managers to adopt a short term orientation of the organisation.

This paper aims to present views which support the argument that ROI and EVA are only viable for the current or short term investments; however, it is not advisable to use the above mentioned indicators when long term orientation or future looking investment projects are in picture. The paper suggests alternative performance indicators, such as Balance Scorecard.

Additionally, the paper also discusses the concept of Transfer Pricing, such as Market based transfer prices; Full cost transfer prices; Cost-plus a mark-up transfer prices; and Negotiated transfer prices.

Discussion

ROI (Return on Investment)

In the world of finance, ROI stands for Return on Investment. It is the most common method that is used by business enterprises to determine or to calculate the feasibility of any investment opportunity or project that is presented to them. Fundamentally it means the expected return per annum against the money that is invested in a project or business deal. ROI has a similarity with the calculation used for calculating the interest rate per annum on the money deposited into the bank account and mostly on profits of stock investment. ROI is very easily understandable and this is the basic reason why so many people feel convenient in benefiting from this model for the possible earnings.

As explained earlier, it is a very easy to use tool which is used for the measurement of the financial return of a project. It is calculated by getting the net benefits had earned, subtract all he costs involved, and compared with the price of the first investment. This is a very common definition in terms of mathematics of an ROI, though a number of different formulas had come up over time. And this is only due to the reason that every company has its specific financial inclinations, and also has so many other factors to consider (Brewer &Clayton 1999).

Formula

The calculation of ROI can be customized in a way that it should answer what a particular industry or company requires.

There are so many key points that need to be understood that ROI could be explained completely.

These are:

Net Profit

Net profit explains the project's total profits minus all the costs which are linked to generate the said benefits or profits. Net profit is sometimes referred as net costs. For some firms it is important to include depreciation value, taxes, and other same things to the calculation of net earnings. On the other side, some don't go for including them because of their ever-changing figures which could only affect the calculation in an adverse manner. This was an example of a tailor-fitting the calculation of ROI for ...