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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Verano Group's board is judging its manager of the Asia division using only division ROCE, which has risen from 14% to 19%. The manager achieved this by deferring equipment replacement and cutting training. Which conclusion best reflects sound financial performance evaluation?

ROCE alone can be flattered by short-term actions such as deferring replacement and cutting training, which boost profit and shrink capital employed while damaging future prospects. The board should supplement ROCE with balanced non-financial and long-term measures rather than reward the manager on the ratio alone.

  1. AThe ROCE rise confirms improved performance, so the manager should be rewarded
  2. BROCE can be manipulated short term through reduced investment and discretionary spending, so balanced non-financial measures should supplement itCorrect
  3. CROCE should be replaced by liquidity ratios, which cannot be manipulated
  4. DDeferring replacement increases asset values, making ROCE a more reliable measure

Explanation

Lower discretionary spending lifts profit and an ageing, depreciated asset base lowers capital employed, flattering ROCE while harming long-term value. A balanced set of financial and non-financial measures reduces this short-termism. Liquidity ratios are also manipulable and do not measure return.

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