Introduction
Generally, when we plan to analyze the performance of any organization we calculate the financial ratios of the company and then critically analyze these ratios with current and past performance and with the results of the competitors. There are some performance measurement tools that require comprehensive data in order to comprehend the performance of the company. With changing dynamics of the business environment and the complexity of the tasks performed by companies, these performance measurement tools are given their due share of consideration by financial analysts now. (Jack, 1997) The company we will analyze is Bank of America. Bank of America is a multinational bank providing financial services to its customers. The headquarter is located in North Carolina. In 2013, the bank was declared as the second largest asset holder of United States. In 2010, it was listed as the third largest company in the world by Forbes.
Return on Investment (ROI) for Bank of America
Return on investment is a performance measurement tool that is used to evaluate the effectiveness of the investment made as compared to the previous investments of the company. This is a popular performance measurement tool because it is simple and provides direct results. Return on investment for the banking sector is based on the return of assets it has invested and the interest and premium bank is able to gain from that investment. If the return on investment is positive it means that it is a viable project to continue investing on. (Patti, 2010)
Figure: Bank of America ROI from year 2013 to 3rd quarter 2014
Source: (CSI Market, 2014)
Source: (CSI Market, 2014)
The above chart demonstrates the quarterly performance of return on investment of Bank of America which is briefly analyzed. It is clear that Bank of America achieved an average return on its invested assets to be 0.95% in the third quarter Sept 2014. This was below the company return on investment. ROI of the company reduced if we compare it with the previous quarter of 1.42%. The major reason for the reduction in return on investment is the decline in net income of the company. The financial sector in which Bank of America operates its six main competitors has achieved a higher rate of investment this quarter. Since the overall industry performance was average in this quarter, the performance ranking in industries for ROI has improved from 482 last year to 60 this year.
Economic Value Added
Economic Value Added is performance measurement tool that is not given its due share of significance. It separates itself from the typical financial indicators and asses the performance of the company by calculating the amount of profit that remains after deducting the total cost of company’s capital including the debts and equity from operating profit of a company. (Ronald, 2001) This sounds simple but the exercise to calculate is vigorous, due to which the results till 2012 will be analyzed only for Bank of America.
Source: (Arnold, 2013)
As it can be clearly seen from the above chart that BAC average assets increased rapidly in 2011 during the period of financial crises. For the bank, the larger asset base is great because, the more it loans out, the more it earns but, on the other hand, the economic value added continued to show declining trend from 2005. The important point to note here is that EVA should have increased with approximately the same percentage of total assets. The pace with which the EVA dropped is astounding from US$ 20 billion in 2005 to US$ 90 billion in 2011. This clearly depicts that Bank of America’s most of the profit in 2012 is utilized in funding the debt and other expenditures that is deducted from the operating profit and little net profit remains back on the table for the company as compared to previous trends. Even though Bank of America had a tough time in adding economic value as compared to the growing asset base but we can see that in mid of 2012, the EVA has instigated to bounce back and will show results in upcoming years. (Arnold, 2013)
Advantages and Disadvantages of ROI
Most popular performance measurement tool is ROI. It has certain advantages and disadvantages that will be discussed briefly:
Advantages
- Companies these days often use ROI performance measurement tool because it is easy to calculate and directly presents the performance of an organization
- Comparisons can be easily made with other companies in the same industry or past year trends and performance ratio.
- ROI can be broken down into different ratios for comprehensive performance analysis such as asset turnover rate or profit margins of the company. (Patti, 2010)
Disadvantages
- It might lead to dysfunctional decisions made by companies evaluating performance based on ROI.
- This tool increases the age of assets, and the managers are inclined to use the same old, inefficient assets based on their numeric performances.
- Different computation practices can lead to confusion.
References
CSI Market (2014) "Bank of America Corporation" http://csimarket.com/stocks/BAC-Return-on-Investment-ROI.html
Josh Arnold (Feb 2013) “Bank Of America: Economic Value Added Portends Huge Gains” http://seekingalpha.com/article/1220241-bank-of-america-economic-value-added-portends-huge-gains
Patti Phillips (2010) "Return on Investment" Handbook of Improving Performance at Workplace chap 53.
Ronald E. Shrievesa & John M. Wachowicz (2001) “Free Cash Flow (Fcf), Economic Value Added (Eva™), And Net Present Value (Npv):. A Reconciliation Of Variations Of Discounted-Cash-Flow (Dcf) Valuation” The Engineering Economist: A Journal Devoted to the Problems of Capital Investment Volume 46, Issue 1.
Jack Philips (1997) “Measuring Return on Investment” American Society for Training and Development
