T.E. Copeland

if you use earnings per share or the gross earnings per share you completely ignore any information about balance sheet management. Consequently, companies that focus on earnings are relatively inefficient in the way that they manage their balance sheet. It actually does make a difference whether you generate one dollar of earnings with one dollar of capital or generate the same dollar of earnings with 50 cents of capital. Other companies use return on invested capital or return on assets employed or return on net assets; there are many definitions of the same thing. What I have found is that those measures are better because the income statement information is the numerator and invested capital is the denominator. This is balance sheet information so it represents an improvement over earnings, but unfortunately if you try to maximise the return on invested capital you tend to harvest your business. The easiest thing to do is to let your invested capital base depreciate in order to increase your return on invested capital and after a while you find that you are not competitive. So that is not a particularly good measure either. In my opinion, the best value based management systems have three levels of measurement. At the corporate level and at the business unit level where you have forecasts of income statements and balance sheet, discounted cash flow is a very good tool. For one period performance measurement the difference between actual and economic profit and expected economic profit is probably the best measure. At the plant level where you don’t have income statements and balance sheets, value drivers are probably the best way of measuring performance. These value drivers include things like defect rates or on-time delivery or the product mix or, in banking, the creditworthiness of the ledgers.

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