Capital Efficiency Measures in Industrial Business—It Is Time to Critically Review These Calculations

Date01 March 2017
DOIhttp://doi.org/10.1002/jcaf.22262
Published date01 March 2017
AuthorAlexander Carl Baumast
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© 2017 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22262
Capital Efficiency Measures
in Industrial Business—It Is Time to
Critically Review These Calculations
Alexander Carl Baumast
The concept of
measuring sus-
tainable share-
holder value by use
of calculations like
residual income, eco-
nomic value added
(EVA),1- return on
capital employed
(ROCE), and others
is a widely discussed
topic over the past
30years. Although
there are still fun-
damental concerns
regarding the useful-
ness of such mea-
sures, many, if not
most, of the big blue-
chip companies have
introduced capital
efficiency measures
both for internal
incentive schemes and for
external reporting purposes.2
The common objective of
these concepts is to avoid man-
agement gaining short-term
benefits by manipulating what
are considered to be more easily
influenceable reporting numbers
like earnings before interest and
tax (EBIT), cash flow, earnings
per share, and so on. Incontrast,
capital efficiency measures are
intended to deliver more reliable
information about (or would at
least provide complementary but
valuable insight in) the long-term
and sustainable prof-
itability of a company
and therefore deliver
a deeper insight into a
companies’ ability to
generate sustainable
shareholder value.
While this article
will not challenge the
usefulness and value
of capital efficiency
measures, it is with-
out any doubt that a
prudent management
of capital in all areas
(including invest-
ment in assets, pay-
ment management,
etc.) is essential for
the long-term success
of a company.
Nonetheless, it is
the case that the cal-
culation of various capital effi-
ciency measures, which is com-
monly used, opens the door
for management to influence
and artificially improve these
numbers without achieving the
desired benefit for the company
and its stakeholders.
Capital efficiency measures like economic value
added (EVA) and return on capital employed
(ROCE) have been developed and are regularly
used by many industrial companies to avoid short-
term bias and provide stakeholders with valuable
insight into the long-term ability of a company to
create value. In recent years, new models have
emerged (partly promoted by the financial indus-
try), which in turn attract management teams to
optimize those capital efficiency figures without
appropriately considering both underlying risk and
long-term benefit for the companies’ stakehold-
ers. This article highlights examples where this
is practiced by shifting of financing sources in
order to achieve an artificial improvement of those
figures. It also provides suggestions to avoid such
misleading results in the future.
© 2017 Wiley Periodicals, Inc.
Editorial Review

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