What is an investment center?

The definition of an investment center is a business unit within an entity that has responsibility for its own revenue, expenses, and assets, and whose financial results will be based on all three factors. A business unit is considered to be any aspect of a business that can be segregated for reporting purposes as a separate operating entity. 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 reporting methods are:

• Cost center. A business unit is judged based on the costs it incurs. The focus is on minimizing costs.
• 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 sales and reducing expenses.
• 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  percentage of sales. This can be achieved with a combination of increasing sales, reducing expenses, and reducing the investment in assets.

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.

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.

Related Topics

Decentralized organizational structure
Divisional organizational structure
Functional organizational structure