Return On Investment: The Pros And Disadvantages Of Return On Investment
However, in spite of its many advantages Return on Investment (ROI) as its drawbacks as well. It is not a very reliable or accurate on way of performance measurement over a period of time. This is because the book value of assets may change each year, it is also capital of distorting the returns due to improper choices. Thus, improper choices could be wrong decisions regarding capitalization of investments, depreciation, exclusion or inclusion of Research and Development etc. This could leads to misleading figures as the returns by engaging in “window dressing” practices (Rappaport, 1986).
Thus, the use Return on Investment (ROI) as a basis of evaluation of performance and strategies at the organization level can lead to bad decisions and to invest through misallocations of resources, thus this could lead to over all bad performance over a period of time (Rappaport, 1986).
In case, there are large numbers of assets that have been invested, they will yield significantly lower returns in the early years. This could be interpreted as bad performance. However, a good performance in future years could be neglected and good investment opportunity may be lost.(Rappaport, 1986).
Return on Investment (ROI) may therefore, not be a good indicative of the returns being in accordance with the strategy of the
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The concept of economic profits gained importance due to demand from shareholders for better performance. This is because shareholder started getting more powers and more rights to voice their opinion in the functioning of the organization. Economic Value Added, shareholder value analysis market values added are all examples of value based methods. They all take into account the cost of capital as well as time value of money and hence measured wealth in economic terms as compared to Return on Investment (ROI) which measures wealth in accounting terms (Weaver and Weston,
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