Investment Center Definition
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.
Table of contents
- 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 revenueRevenueRevenue 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., therefore exemplifying cost centersCost 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.. 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 profitabilityProfitabilityProfitability 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. 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.
The investment divisions may have diverse objectives. However, the major focus will be on revenue generation, cost controlCost 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., 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 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., specifically income statementsIncome 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. and balance sheetsBalance 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.. The financial statement disclosing the net income of the investment division eases the Return on investment (ROI) calculations. The profit margin formulaProfit 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. is used to derive ROI values; the product of profit marginProfit 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. and asset turnoverAsset 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. gives the return on assetsReturn 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..
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 subsidiarySubsidiaryA 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. entities as investment divisions.
Starbucks Corporation is the American company with the largest coffeehouse chain globally. They engaged in vertical and horizontal integrationHorizontal 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. 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 companyParent 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., 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:
- It helps organizations identify profit-maximizing products or revenue streamsRevenue StreamsRevenue streams refer to the different sources through which the company generates profit, such as selling the products, catering the services or offering a combination of goods and services to the clients..
- It helps ascertain whether some of the business’s resources may potentially become too costly for the firm or not.
- Focus on maintaining the optimal levels of inventory and receivables.
- Eases the process of expansion.
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 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. 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.
|Investment, cost, and revenue
|Cost and revenue
|Return on investment (ROI), residual income (RI)
|Actual profit compared to a budgeted 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)
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.
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.
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.
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 –