The Concept of Return

Money metrics

Return on investment

Every investor has some understanding of the idea of return on investment … simply put, it is the income expected from an investment, with the expectation also that the investment itself will be returned in due course. Return on investment is all about money flows … the amount of money put in … and the amounts of money that get returned.

The mathematics are also well known … as well as the impact that externalities like tax regimes, exchange control and other matters may have on the return!

Return on sales

People who do the analysis of a business may also be interested in the return on sales, that is the profit that is earned relative to the sales volume. This serves as a useful measure of how efficient a company is and how healthy is the business. If the sales margin is low and the return on sales is low, the business will have difficulty if it gets faced with low cost competition.

Return on capital employed

Return on capital employed is very similar to return on investment. The main difference is the perspective with return on capital employed an internal metric while return on investment may be thought of as an external metric.

In corporate financial analysis the return on capital employed is increased when there is financial leverage. The mathematics of financial leverage are very attractive as long as risk is ignored and not brought into the analysis. With risk fully accounted for, highly leveraged investments are less attractive.

Return on assets employed

In money accounting it is common to assess performance using return on investment and return on capital employed. It is less common to measure performance using return on assets employed.

Return on assets employed is a very good measure of business performance … being the amount of income generation relative to the assets used to earn this income. This measure is very useful in determining what part of a business is making the best use of the available resources. The advantage for return on assets employed is that this enables comparison of performance based on the resources needed to be deployed … separately from the financing associated with the resources.

More meaningful value metrics

Performance taking profit and value into account

TVM is a combination of profit and value metrics. Money profit and cash flow are needed in order “to pay the bills” and to enable the functioning of the global money based economic system … but this is not enough. TVM also has a value dimension so that value flows are also captured in the system of metrics just as the money flows are captured in corporate accounting.

Value return on money expended

When money is consumed there is the expectation of a return. In TVM this return is a value return that combines the profit realized with the non-money value added to produce a measure that is the value return on money expended. Note that the non-money value added in calculated using value consumed not money cost, and value created not just money revenues earned.

The results of the value return on money expended are vastly different from the money profit return on investment. Some highly profitable practices have value destruction that are presently ignored, and some low profit activities have value adding that are huge.

Value return on resources consumed

This is a core measure of performance in TVM. It is a basic measure of quality of life improvement relative to the resources that are consumed. This measure changes the paradigm from “more and more and more” is progress to one where the metrics reflect the efficiency of society in delivering quality of life.

What equivalent in the social sector

Before the development and deployment of TVM the equivalent set of analytical metrics did not exist in the social sector. Cost benefit analysis is done to help justify projects and programs, but these metrics are rarely integrated with the operational metrics of the organization. Decision making for society is not easy … but it is likely that it is being done far more badly than it needs to be, simply because there is not much useful data that would improve decision making, and increase the fact base about costs and impacts.

Law allows inadequate accounting

In most countries the law allows government and public sector organizations as well as not-for-profit organizations to use cash based accounting and fund accounting rather than the full accrual GAAP accounting used almost universally by the business sector. These organizations do not therefore have full balance sheet accounting, and their ability to do analysis is severely compromised. Most problematic is the manner in which critical assets are inadequately maintained … and critical investments do not get made.

The TVM initiative uses balance sheet as the central core of the analytical framework … something that has served the corporate community well for a very long time … with some notably recent exceptions when the basic tenets of balance sheet accounting were ignored by laws and rules that allowed unprincipled financial reporting.

Example … TVM applied to malaria

The basic framework of TVM is (1) “state” which is like the business balance sheet but reflecting the perspective of society; (2) “progress” which is the change in state over a period of time; and, (3) “performance” which relates to the economic activities, the use of resources, how efficiently they were used and how effective they were in achieving tangible results.

A complex program like Integrated Malaria Management (IMM) needs good data for day to day operations, and these same data inform TVM for performance metrics at the same time. The data framework works along the following lines: (1) There is a before situation (2) there are activities, and (3) there is an after situation.

TVM … Integrated Malaria Management

In this malaria example, there are four steps: (1) Before ... there is a certain situation with malaria and mosquitoes ... and with the human host; (2) Interventions are planned reflecting the data about the problem; (3) Interventions are carried out … costs are incurred; and, (4) After ... data shows a new state about malaria, mosquitoes and the human host. The interventions have costs … the community sees results … there are metrics about cost efficiency and cost effectiveness.

What are the key questions?

There are two sets of questions: Set 1 about effectiveness: (1) How much did the activities cost (2) how much change from before to after … therefore how much impact. This answers the question about effectiveness of the work done.

And then there is Set 2 about efficiency: (1) How much did the activities cost, and (2) how much should the activities have cost. This answers the question about the efficiency of the work done.

These key questions will help a decision maker to have the most cost effective operation … that is, the least cost or value consumed for the greatest value increment. If the value is properly assessed the value will reflect important issues like risk, sustainability and long term implications … which are not always easy to do, but they should not be ignored.

How much change? How much impact?

There are four things that need to be measured before and after: (1) the prevalence of malaria parasite in humans; (2) the prevalence of malaria parasite in mosquitoes; (3) the morbidity of humans caused by malaria (4) the mortality of humans caused by malaria.

The change in these parameters have value … and these values may be computed based on the population and the standard values for these items.

How much efficiency? How much effectiveness?

How much of each intervention was done and how much did it cost. How much would each of these interventions have cost based on the standard costs and the amount done?

How much should it have cost?

Many experts in development shy away from the cost question like the plague. In most activities the costs are very high relative to what might be considered a commercial norm. Experts in development may not earn millions of dollars but they do live an expensive life style that gets costed into the work. They are also constrained in all sorts of ways from doing what might be the most efficient … they are usually part of a government driven operational set up … another endemic cause of high cost low performance.

How much was the cost of the interventions relative to the value of the malaria control impact. This should be a rather easy computation based on the standard values of malaria control quality of life improvements.

Experience shows that it is relatively easy to reduce the impact of malaria in a society with intensive high cost interventions … like for example insecticide treated bednets. But experience also shows that malaria rapidly returns when the interventions are discontinued and there is no continuing program. TVM nets the impact from discontinued program in the future with impact from the implemented program today. TVM also takes into account items like resistance that emerges over time when there is continuing intensive interventions using mono-therapy without careful attention to all the issues.

Unreliable methodology

It has become a common practice to do a small study to show that something works and produces value adding ... and then scale up and assume that the value adding will scale up as the “how much has been done” scales up. Cost accounting (and industrial engineering) in the corporate experience shows that this rarely happens.

What is vital is to understand the behavior of both costs and values. The goal is to get costs reduced without losing the value of the work. There is a point where more cost reduction results in lowering of the value of the work.

The measurement of value has a large subjective component ... but it is still possible to have some useful measurement. By using the concept of standard value ... a concept rather similar to standard costs ... it is possible to compare different programs and see how one program performs relative to another.

In the case of malaria control programs, the goal is to reduce mortality and morbidity. By having a table of standard values it is possible to report that one approach had more value relative to the costs than another.