Subscribe and listen to AW’s podcast!
Subscribe and listen to the Automation World Gets Your Questions Answered podcast!
Listen Here

To Track ROI, Define It First

There are no standard definitions for ROI and ROA

Aw 5068 A06p11a

When tracking return on investment (ROI)—used traditionally to determine how much time it takes to recover an investment—the most important issue is calculating reality, says Peter Martin, vice president, performance measurement and management, Invensys Production Management (www.invensys.com), in Foxboro, Mass.Thus, return on assets (ROA) may be a better indicator, Martin says. The principal reason is that ROI calculates reduction in costs of operating automation systems. "But automation, an investment, is a supporting asset. Its function is to make base assets—energy, equipment and the like—operate," he notes.

The tide is beginning to turn toward the use of ROA, Martin observes. "I think people are changing from [looking at] the technology itself to what the technology asset is," he says. That means end-users are looking at automation based on how it improves performance of base assets, he explains. ROA provides significantly faster payback, he adds. "If manufacturers look at ROI from an automation perspective, it takes about 12-18 months to recover [the investment]," says Martin. "But if you look at it (automation) from the plant [operations] perspective, we see the average 100 percent return being one to two months."

Gut-feel automation

Even so, in general, manufacturers still install automation by gut feel, he observes. Noting that ROA is not without drawbacks, Martin explains that indicator’s ambiguity: "If I were to tell you the team batting average of the Boston Red Sox was .262, can you tell me who is the team’s most productive hitter? It’s the same with ROA."

Calling ROI and ROA "essentially dangerous," Robin Cooper, Ph.D., professor of management accounting at Emory University’s Goizueta Business School (www.goizueta.emory.edu), emphasizes that both are relative terms and must be used cautiously.

However, ROA might be used to compare two options. "But by the time you start decomposing these things, in comparing an old plant with a new plant, with identical assets and profits, one plant would have a higher ROA or ROI," Cooper says. "The old plant would have better apparent performance than the new plant." For that reason, he thinks neither ROI nor ROA are good things to use in cross-plant comparisons.

For certain, anyone using ROI and ROA should first identify the exact definitions of total assets being used in either comparison, Cooper warns. "And make sure they are apples-to-apples, not apples-to-oranges, comparisons." Noting that there is considerable variation in how both indicators are used, he adds, "The most fascinating thing about ROI and ROA is that there are about as many different definitions of each as there are sources of definitions of each."

Agreeing with his assessment is Sandra Richtermeyer, Ph.D., professor of accountancy at Xavier University (www.xavier.edu), Cincinnati, and professor-in-residence at the Institute of Management Accounts (www.imanet.org), Montvale, N.J. "There are no standardized definitions for ROA and ROI. That’s why they’re used in different contexts," she observes.

But Cooper and Richtermeyer believe that ROI and ROA, as used today, still may have utility. "If you use ROI or ROA within a single entity, you get a directional signal. And if you at least get the definitions right, then you can look at two plants’ (or automation systems’) performance and stand a chance of seeing how these terms relate to one another," Cooper says.

"As long as you can agree upon consistent definitions of what’s in the numerator (net income) and denominator (investments for ROI and total assets for ROA), then you’re comparing apples to apples," emphasizes Richtermeyer. She believes that accountants need to be actively involved with engineers in establishing and then agreeing on what to include in ROI and ROA calculations. "And have those terms consistently applied and in a meaningful manner."

C. Kenna Amos, ckamosjr@earthlink.net, is an Automation World Contributing Editor.

Test Your Machine Learning Smarts
Take Automation World's machine learning quiz to prove your knowledge!
Take Quiz
Test Your Machine Learning Smarts
Revealed: Sensor & AI Secrets
New report features peers and pros on how machine vision, smart instrument sensors and AI can improve manufacturing.
Download e-book
Revealed: Sensor & AI Secrets