Return-on-Assets and TME Management, Part 2 of 3
Charles Motzko- September 23, 2012This series (see Part 1) is intended to only provide a starting point for further research as to the best method to measure the aggregate performance of the TME (test and measurement equipment) management function.
In this part 2, I look at a more elegant approach using ROA (Return-on-Assets) based on the traditional DuPont Analysis Model. Part 3 will compare the two methods.
Return-on-Assets is typically used as an indicator of how profitable an organization is relative to its total asset base (TME Pool). ROA gives an idea as to how efficient management is at using its assets to generate revenues. ROA is usually presented as a set of percentages. Sometimes this is referred (improperly) as "return on investment".
The basic formula for ROA calculation is:
Note: Some managers will add interest expense back into net income when performing this calculation because they'd like to use operating returns before
cost of borrowing.
When the analysis is structured properly, ROA tells you what earnings (value-add derived from the TME pool) were generated from invested capital (cost of the TME assets and support). In order for one to use this form of analysis, one must have a complete understanding of the finance and accounting principles of the organization and how these functions relate to the TME pool and operations.
Note: Property Management has been using this type of analysis for better than 50 years, so there is rigor in the performance model development.
By definition: ROA is a series of ratios that approximate the value-add of the measurements derived from the TME inventory. In the most basic form, ROA can be decomposed into the various factors influencing TME inventory performance.Following the structure of the DuPont Analysis, you can begin the formulation starting with the following:
The key here is to have the ability to identify and separate the Value-add derived from measurements versus the operating cost or more commonly identified as the total cost of measurements. The difference should be greater than one. If less than one, the test protocol and supporting TME need to be reevaluated for effectiveness. The reason is the measurement value-add should be greater that the return.
Where, from the financial analysis perspective (all denominated in dollars, unless otherwise noted) the assumptions for each element are:
Assets = The OAC (Original acquisition cost) of the TME Pool, including all the fixed assets. Salvage and book values are an accounting artifacts and primarily used for strict financial analysis.
Fixed Assets = The OAC of the fixtures, tooling, rolling stock, calibration TME, etc. required to maintain and deploy the TME.
Operating Cost = The actual cost of the logistics, service and support (including people, floor space, IT support, calibration & other related cost)necessary for the normal operation of the TME pool, include consumables and accessories.
Revenues = The revenues derived from the end item excluding all Assets (as defined).
Turn-over = Number of measurements that provide the value-add.
Choosing the right performance measurement model and measurands can be a daunting task because you must consider all the factors involved. TME pool managers must consider and denominate all the factors in the value add of the services they perform.
When considering the factors involved in your current performance measurement scheme, you must consider if there are ways that the traditional methods and practices can be blended with a financial-based model to better validate the value-add that a TME pool brings to the organization. Anything that impacts the service quality, reliability, or responsiveness will have a direct impact the organizations effectiveness and efficiency (see Part 1). While the cost of the TME pool will always be a consideration, can you frame the worth of the services in financial terms senior management will understand?