Instruments to assess everyday functioning have utilized self-report, proxy report, clinician ratings, or direct observation of performance. Each of these methods has strengths and weaknesses. In this article we argue for the inclusion of performance-based measures of functional capacity in studies of severely mentally ill persons and describe a new measure, the UCSD Performance-Based Skills Assessment (UPSA). We administered the UPSA to 50 middle-aged and older outpatients with schizophrenia or schizoaffective disorder, and 20 normal comparison subjects. Participants' performance in five domains of functioning (Household Chores; Communication; Finance; Transportation; and Planning Recreational Activities) was assessed in standardized role-play situations. Administration of the UPSA required an average of 30 minutes to complete. Interrater reliability of ratings was excellent. Patients' performance was significantly more impaired than that of normal subjects. Among patients', the UPSA performance correlated significantly with severity of negative symptoms and of cognitive impairment but not with that of positive or depressive symptoms. The UPSA scores correlated highly with those on another performance-based measure. We believe that UPSA would be useful for assessing everyday functioning in severely mentally ill adults.