An investment center is a business unit within a firm that utilizes its own capital to directly contribute to the company’s profitability. It stands apart from a profit center or cost center by encompassing the management of revenues, expenses, and assets to optimize financial performance.
Companies evaluate the performance of an investment center based on the revenues it generates through investments in capital assets compared to its overall expenses.
Key Takeaways
- An investment center is a business unit that leverages its own capital to generate returns, thereby benefiting the company.
- Common examples of investment centers include the financing arm of an automobile maker or a department store.
- As financialization grows, investment centers are increasingly important for companies seeking profits from both investment and lending activities beyond core production.
Understanding Investment Centers
Business units within a company are categorized as either generating profits or incurring expenses. Organizational departments are typically classified into three types: cost centers, profit centers, and investment centers.
- A cost center focuses on minimizing expenses and is evaluated based on the costs it incurs. Departments like HR and marketing fall under this category.
- A profit center is assessed on the profits it generates, either by increasing sales or reducing costs. Examples include the manufacturing and sales departments.
- An investment center is responsible for its own revenue, expenses, and assets, and manages its own financial statements, such as the balance sheet and income statement.
An investment center stands as an extended version of the profit center, with the added responsibility of measuring and managing the assets invested in it to assess its true profitability.
Investment Center vs. Profit Center
Unlike profit centers which are assessed based on their generated profits or expenses, investment centers focus on returns from fixed assets or working capital invested in them.
An investment center might invest in unrelated activities or acquisitions for risk diversification. For instance, established corporations often create venture arms to invest in next-gen trends via startup stakes.
In simpler terms, a department’s performance is analyzed by examining how well it uses its allocated assets to generate revenue against the expenses incurred. This approach, focusing on return on capital, offers a clearer picture of a division’s contribution to the company’s overall economic health.
Investment Center vs. Cost Center
Unlike cost centers which don’t directly contribute to profitability and are assessed by their operational costs, investment centers utilize capital to acquire other assets and drive profitability.
Companies employ various metrics, such as return on investment (ROI), residual income, and economic value added (EVA), to evaluate an investment center’s performance. For example, comparing a division’s ROI to the cost of capital can reveal inefficiencies in capital management. If a division exhibits an ROI of 9% versus a 13% cost of capital, it indicates poor management of capital or assets.
Related Terms: revenue, capital assets, cost center, profit center, subsidiary, assets, financial statements, balance sheet, income statement, return on capital.
