Management Accounting Performance Measures: EVA, ROI, RI, and the Balanced Scorecard

Return on Investment (ROI)

Return on investment (ROI) is the most widely used divisional performance measure in practice. It is simple, intuitive, and comparable across divisions of different sizes:

ROI is useful for comparing divisions of different sizes (percentages are comparable) and for trending performance over time. However, it has a fundamental flaw that produces perverse managerial incentives in practice.

Problems With ROI as a Performance Measure

The core problem: a manager rewarded on ROI will reject investments that are profitable for the company as a whole if those investments would lower the division's ROI. Suppose the company's cost of capital is 10% and Division A's current ROI is 15%. A new investment earning 12% would benefit the company (12% > 10% cost of capital) but reduce Division A's ROI from 15% to something between 12% and 15%. A manager maximising ROI will reject the project — acting against shareholders' interests.

This is the ROI suboptimisation problem: divisional ROI maximisation leads to company-level underinvestment whenever attractive projects earn less than the existing divisional ROI. For companies with high-ROI legacy divisions, this is a significant practical problem. The solution is residual income.

Residual Income: A Better Metric

Residual income (RI) is operating income minus a capital charge — the cost of the capital invested in the division multiplied by the required rate of return:

Residual income aligns divisional managers with corporate interests: any project earning above the required rate of return (cost of capital) increases RI and will be accepted. The ROI suboptimisation problem disappears. RI is measured in dollars, not percentages, which makes it harder to compare across divisions of different sizes — but it produces better investment decisions.

Economic Value Added (EVA)

Economic Value Added (EVA), a concept developed and trademarked by Stern Stewart & Co., is a refinement of residual income that adjusts both the numerator and denominator for specific GAAP distortions:

The adjustments produce a measure of economic profit that is less susceptible to manipulation through accounting choices. A positive EVA means the company earned more than its cost of capital — value was created. A negative EVA means value was destroyed even if GAAP net income was positive. Companies like Coca-Cola, AT&T, and many others have used EVA as their primary internal performance measure and tied executive compensation to it. For the WACC calculation that EVA depends on, see the WACC guide.

The Balanced Scorecard

The Balanced Scorecard (developed by Kaplan and Norton in the 1990s) addresses a fundamental weakness of purely financial metrics: financial results are lagging indicators — they tell you what happened, not what will happen. A company can produce strong short-term financial performance by cutting R&D, deferring maintenance, and ignoring customer satisfaction — destroying future earning power while looking good today. The balanced scorecard adds leading indicators to balance the lagging financial measures.

The Four Perspectives

Financial perspective: Lagging indicators of financial performance — revenue growth, profit margins, ROI, EVA, cash flow. These answer: "How do we look to shareholders?"

Customer perspective: Measures of how the company is delivering value to customers — customer satisfaction scores, market share, customer retention and acquisition rates, net promoter score. These answer: "How do customers see us?"

Internal business process perspective: Efficiency and quality of key processes — manufacturing cycle time, defect rates, order fulfillment speed, innovation pipeline metrics. These answer: "What must we excel at?"

Learning and growth perspective: Foundation for future performance — employee training and skills, information system quality, employee satisfaction and retention, ability to introduce new products. These answer: "Can we continue to improve and create value?"

The causal logic flows upward: learning and growth enables better internal processes → better processes improve customer outcomes → satisfied customers drive financial results. A well-designed balanced scorecard identifies the specific drivers at each level and creates metrics that measure those drivers.

Choosing the Right Metric

For investment decisions within a division, residual income (or EVA) is superior to ROI because it eliminates the suboptimisation problem. For comparing performance across divisions of very different sizes, ROI may still be useful as a supplemental measure. For aligning management with long-term value creation, EVA with WACC as the capital charge provides the clearest signal. For managing non-financial leading indicators of future performance, the balanced scorecard is the most comprehensive framework.

In practice, most organisations use multiple measures — financial and non-financial — recognising that no single metric captures all dimensions of performance. The danger is measurement overload: too many metrics produce confusion and misalignment. The art is selecting the few measures that most directly drive the organisation's strategic objectives. See the related discussion of variance analysis in the variance analysis guide.