Investment center definition
/AccountingTools What is an Investment Center?
An investment center is a business unit within an entity that has responsibility for its own revenue, expenses, and assets, and whose financial results are based on all three factors. It is considered to be any aspect of a business that can be segregated for reporting purposes as a separate operating entity, usually in the form of a division or subsidiary. An investment center typically has its own financial statements, comprised of at least an income statement and balance sheet. Management evaluates an investment center based on its return on those assets (and offsetting liabilities) invested specifically in the investment center.
The investment center is the most sophisticated of the various methods of reporting the results of a business, since it encompasses all financial measures of performance. The three possible reporting methods are noted below.
Cost Center
A business unit is judged based on the costs it incurs. The focus is on minimizing costs. A cost center is usually an administrative unit of a business, such as its accounting department or treasury department.
Profit Center
A business unit is judged based on the profits it generates. The focus is on increasing profits, which can be achieved through a combination of increasing revenues and reducing expenses. A profit center is usually organized to sell a specific set of a company’s goods or services.
Investment Center
A business unit is judged based on its return on investment. The focus is on increasing this return, both in total dollars and as a percentage of sales. This can be achieved with a combination of increasing sales, reducing expenses, and reducing the investment in assets. An investment center is usually organized as a separate company subsidiary.
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Investment Centers vs. Cost Centers
An investment center is judged on the amount of profit it generates, as well as its return on assets. This is not the case for a cost center, which is only judged based on whether it can control its costs. Thus, a cost center is a subset of an investment center; they are both responsible for costs incurred, but a profit center is also responsible for revenues generated and the return on assets employed. Given their more expansive range of responsibility, entire businesses and product lines are typically tracked as profit centers. Conversely, administrative departments are more likely to be tracked as cost centers.
Investment Center Metrics
An investment center is the most complex type of reporting entity, so it is not sufficient to measure its performance simply based on its sales, costs, or profits. Instead, the best approach is to measure its return on investment, which compares the asset base of an investment center to the profits generated. Cost centers and profits centers do not use this measurement, because they are not responsible for the assets used in their operations.
Advantages of Investment Centers
The investment center concept is most useful in situations where there is a large investment by a business unit in fixed assets and/or working capital. In this case, it is essential to monitor how efficiently and effectively these assets are deployed.
Disadvantages of Investment Centers
The return on investment (ROI) percentage at the core of the investment center concept is subject to manipulation, since the manager of a business unit can increase ROI by artificially drawing down asset usage to levels that are harmful to the long-term prospects of the business.
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