What do you understand by investment Centre explain the methods used for measuring investment center performance?

An investment center is an investment division or department or unit, or responsibility center within an organization. Instead of classifying this one as a cost or profit center, the organization classifies this unit as an investment center. And this unit/center remains responsible for its own revenue, expenses, and assets. The activities of such units may be totally different from the organizations’ core operations and mostly relates to the utilization of capital. Hence, usually, it is called an investment division.

All three factors (revenue, expenses, and assets) determine the performance of such a business unit. However, in this case, the key differentiator is that this center’s performance is judged by its use of capital and the return on assets it generates, rather than judging the performance based on its costs and profits like any other cost or profit center.

We can also say that an investment center is any business unit that the management can segregate for reporting purposes. Or a unit that can work as a separate operating entity or a subsidiary. These centers usually prepare their own financial statements. Along with generating income from the core business activities, these units can generate revenue from investing or lending capital.

ROI – Key Performance Benchmark

As we discussed above, return on assets or ROI (return on investment) remains the core yardstick or the core concept of the investment division or center. Because this indicator helps management to judge/evaluate/compare the performance of this division. Such a concept usually suits the organizations with a massive fixed-asset investment. The finance departments of the department store are a good example of investment centers.

For the purpose of accounting, we need to treat these units as separate entity that has their own financial statements. For external reporting, the financial statements of these centers are merged into the organizations’ report cards.

Characteristics

There are three main characteristics of an investment center, and these are:

• Like any other profit center, this division also remains and is treated as an independent business unit. And this division remains responsible for its own revenues, expenses, and assets.
• The core idea or objective of creating such a division is to boost the profit of the organization by using the investments/fixed assets and capital. In other words, maximizing of return on the assets/investments/capital is the key objective. 
• Management determines their performance on the basis of the return they generate on their assets.

Measuring Performance of Investment Center

The performance of a profit center depends on the profit it generates. And the performance of a cost center depends on the variation between a department’s actual and budgeted costs.

In the case of an investment center, the performance evaluation considers the assets and resources that the department gets and how well that unit is using those resources and assets to generate revenues in comparison to their total expenses. Such a unit is free to use capital and other funds to buy more assets to boost its revenues.

Looking at the ROI of a department is very helpful in business scaling. So, on the basis of ROI, if a department is not performing well, then the management can either close it or reduce their capital allocation or further allocation. Managers, however, can manipulate ROI to ensure their performance is always above par.

Along with ROI, there are a few more metrics that can help in measuring the performance of these units. These metrics are:

Investment Center – A Different Viewpoint?

If you are not already aware, there are primarily two ways in which an organization can categorize its departments. These are profit centers and cost centers. As is evident, the performance of profit centers (manufacturing and sales department) depends on the profits they generate, and the performance of cost centers (human resource or marketing departments) depends upon the cost (versus estimates).

In contrast, an investment center’s performance depends on the return on the assets it generates and its revenue and expenses. It will not be wrong to call such a unit or department an extended profit center.

We can say that an investment center is a more modern concept. Rather than identifying divisions as profit or cost centers, management views those departments as investment centers. So, in a way, it is basically a different way of looking at departments that may also be a profit or cost center.

However, unlike a profit center, an investment division could take up activities that are different from the organization’s core operations. For instance, such a unit could take up investments or acquisitions. Lately, we have seen big companies establishing a venture arm within an organization. Such a unit primarily invests in start-ups. The whole idea is to generate and maximize profits with the available resources.

Final Words

With a focus on the return on capital, the concept of an investment center paints a more accurate image of how a unit is contributing to the overall success of the organization. This assists management in deciding whether to extend or curtail the resources of such units or to close down such units completely. Creating such units or capacities within the organization helps it optimize resource utilization; there remains no idle capital, or there remain no loss-making investments on a continual basis. These activities effectively improve the performance of the business.

1. Investment Center [Source]
2. What is an Investment Center? [Source]

An investment center refers to an organizational unit where the manager is responsible for expenses, revenue, and investments. The parent company has delegated adequate authority to the manager or the head of the unit to decide, implement and manage the unit’s operation.

It is a type of responsibility center like profit and cost centers of a company. They focus on investing in assets that help grow the unit and contribute to the parent company’s profitability. The yield on invested capital is used to assess the performance of an investment division.

• An investment center is a part of a company usually acting as a distinct entity responsible for investing in assets, controlling cost, and generating revenues.
• The managers or head of the investment division has to generate profit proportional to the investments done by the division.
• The performance of the investment division is measured in terms of the profit generated from the investment in assets using metrics like return on investment (ROI) and residual income (RI).
• It is different from profit centers that are not concerned about investment decisions.

Investment Center Explained

An investment center is an inherent part of large corporations. Companies have different units with different functionalities. For instance, HR departments manage the employees, and accounting departments deal with company accounts; both departments incur an adequate cost for functioning without creating any revenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more, therefore exemplifying cost centersCost center refers to the company's departments that don't contribute directly to the corporate revenue; however, the firm has to incur expenses for keeping such units operative. It comprises research and development, accounting and human resource departments.read more. The sales and production departments are profit centers since they are responsible for revenue generation. The investment division has the flexibility to make investments to generate returns to improve the profitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more of their division. 

The process of segregating and categorizing different units of an organization into responsibility centers predominantly serves to analyze a department’s performance in terms of how well they have used the resources available to them. The management cannot use the same performance measures for gauging the advancements of different units. For instance, for cost centers, the measurement will be based on the cost incurred for a certain output, whereas for investment division, they need to access the return on investments.

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Source: Investment Center (wallstreetmojo.com)

The investment divisions may have diverse objectives. However, the major focus will be on revenue generation, cost controlCost control is a tool used by an organization in regulating and controlling the functioning of a manufacturing concern by limiting the costs within a planned level. It begins with preparing a budget, evaluating the actual performance, and implementing the necessary actions required to rectify any discrepancies.read more, and investing in assets. Other objectives include:

• Effective delegation of duties
• Contribute to growth of parent organization
• Motivate and empower managers
• Quick implementation of decisions

Investment divisions are significant in decentralized organizations for efficient and effective functioning. It represents a form of a small company. Sometimes they have their financial statementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more, specifically income statementsThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more and balance sheetsA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more. The financial statement disclosing the net income of the investment division eases the Return on investment (ROI) calculations. The profit margin formulaProfit Margin can be calculated by dividing the gross profit by revenue. Profit margin formula measures the amount earned (earnings) by the company with respect to each dollar of the sales generated. read more is used to derive ROI values; the product of profit marginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more and asset turnoverThe asset turnover ratio is the ratio of a company's net sales to total average assets, and it helps determine whether the company generates enough revenue to justify holding a large amount of assets under the company’s balance sheet.read more gives the return on assetsReturn on assets (ROA) is the ratio between net income, representing the amount of financial and operational income a company has, and total average assets. The arithmetic average of total assets a company holds analyses how much returns a company is producing on the total investment made.read more.

Investment Center Example

Investment divisions are relevant in a growing business scenario. Most companies ease the operation by having different types of investment divisions. Let us consider the investment center examples of having subsidiaryA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company.read more entities as investment divisions. 

Starbucks Corporation is the American company with the largest coffeehouse chain globally. They engaged in vertical and horizontal integrationHorizontal Integration is a merger that takes place between two companies operating in the same industry. These companies are usually competitors and merge to gain higher market power and economies of scale, an extensive customer base, higher pricing power, and lower employment cost.read more strategies while gaining new markets and customers. As a result, they now have many divisions and subsidiaries acting as distinct entities. Examples of subsidiaries of Starbucks Corporations are Corporacion Starbucks Farmer Support Center Columbia, Starbucks Manufacturing Corporation, and Starbucks Capital Asset Leasing Company, LLC. For the parent companyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies.read more, these subsidiaries are investment divisions.

Let’s consider another example of ABC Inc., MNC engaged primarily in the apparel and sports equipment business. They have retail stores across the globe. For the ease of doing business and enabling quick investment decisions which align with the host country’s environment, its entire retail stores in a country will come under the ruling of the investment division functioning in that country.  

Advantages & Disadvantages

Following are some of the advantages of having investment divisions:

Following are some of the disadvantages:

• Funding the initiation of such centers/divisions may be especially difficult for smaller firms or startups.
• If investing in alternative financial vehicles, then the investment can be susceptible to market volatility.

Investment Center vs Profit Center

The investment and profit centerProfit Center is the segment or division of a business responsible for generating revenue & contributing towards its overall profit. Here, the objective is to increase sales & reducing the cost incurred. read more differ from each other. For example, making investments and enhancing the profit proportional to the investment done is a major concern for the investment division manager, unlike the profit center manager responsible for making the projected profit.

The profit center manager has to decide on input mix, product mix, selling prices, and output quantities. At the same time, the investment center manager has the power to determine capital investment requirements along with input mix, product mix, selling price, output quantities to boost productivity.

Frequently Asked Questions (FAQs)

What are the profit center and investment center?

Both are responsibility centers of an organization. Profit center managers are responsible for the cost incurred and profit generated by the unit. However, they don’t have the power to decide the investments. The investment division manager is held responsible for the cost, revenue, and acquisitions in assets.

How is investment center income calculated?

Various techniques are used to evaluate the performance of the investment division, such as return on investment (ROI), residual income (RI), economic value added (EVA). ROI is derived by dividing the income (return) by investment, RI is the difference between income and expected target return, and economic value added (EVA) is the difference between after-tax earnings and the cost of capital.

What is an investment center in accounting?

The investment division manages its revenue, expenses, and assets. These are the main factors determining the center’s financial performance. Accordingly, it can be treated as a distinct entity for accounting purposes.

Recommended Articles

This has been a guide to Investment Center and its definition. Here we discuss how investment centers objectives along with examples, advantages & disadvantages. You may learn more about financing from the following articles –

• Responsibility Center
• Cost Center
• Cost Center vs Profit Center