Residual Income as a measure of managerial performance. Include Essay

Residual Income as a measure of managerial performance. Include examples of usage today and advantages and disadvantages - Essay Example In business, residual income represents a specific financial amount derived from an equation which subtracts invested capital from total, pre-tax profitability (Accaglobal.com, 1999). Where the traditional return on investment (ROI) template, which calculates a percentage by dividing the average operating assets from net operating income, residual income is represented in actual dollars through its calculation. Professionals argue that residual income (RI) may not necessarily reflect the total performance of a managerial professional, hence there is the debate as to whether compensation directly linked to RI totals is a fair measure of reward for performance. This paper examines the contemporary usage of residual income as a performance measure. There are several viable calculations to determine residual income (RI), with the most common being operating income minus the required return on investment in dollars (Marshall, McManus & Viele, 2006). A second method is subtracting required income from actual income, representing a final financial (not percentage) total, indicating either a negative or positive residual income (Economist, 1996). For instance, if the actual income of the firm is $100,000 and required income (often calculated from ROI) is $50,000, the firm has experienced a residual income increase of $50,000, which may indicate that the company executive leadership has made positive strides in boosting profitability. When ROI is used in the equation to determine residual income, positive RI occurs when actual ROI is greater than the minimum required ROI. These calculations may sound very simplistic and relatively straightforward, however, calculating residual income is not always a fair measure of total executive performance, especially when a particular company has experienced years of negative residual income. For instance, assume that a firm maintained a negative residual income for