What Is an Investment Center?

What Is an Investment Center?

Let me explain to you what an investment center is—it's a business unit in a company that takes responsibility for generating profits by making its own capital investments and handling its own revenues, expenses, and assets.

You can think of it in comparison to terms like 'profit center' or 'cost center' that you might have heard before.

When companies look at an investment center's performance, they focus on the revenues it generates from investments in capital assets versus the total expenses involved.

Sometimes, people refer to it as an investment division.

Key Takeaways

An investment center is essentially a business unit that a company uses with its own capital to produce returns that benefit the overall firm.

You'll see common examples in the financing arms of automobile makers or department stores.

These centers are becoming more crucial for companies as financialization pushes them to chase profits from investments and lending alongside their core production activities.

Understanding Investment Centers

In a company, different departmental units get categorized based on whether they generate profits or just incur expenses. We classify them into three types: cost center, profit center, and investment center.

A cost center aims to minimize costs and gets judged by the expenses it racks up—think human resources or marketing departments.

A profit center gets evaluated on the profits it generates, working to boost them by increasing sales or cutting costs; this includes manufacturing and sales departments. Beyond departments, these can be divisions, projects, teams, subsidiary companies, production lines, or even machines.

Now, an investment center handles its own revenues, expenses, and assets, managing its own financial statements like a balance sheet and income statement. Because you have to track costs, revenues, and assets separately, an investment center is typically a subsidiary or division.

You can see it as an extension of a profit center where we measure revenues and expenses, but here we also measure the assets used and compare them to the profits earned.

Investment Center vs. Profit Center

Unlike a profit center that just looks at profits or expenses, an investment center zeros in on generating returns from the fixed assets or working capital specifically invested in it.

An investment center can put money into activities and assets not directly tied to the company's main operations, like investments or acquisitions in other companies for risk diversification.

A growing trend is established corporations setting up venture arms to invest in startups and grab stakes in emerging trends.

In simple terms, we analyze a department's performance by looking at the assets and resources allocated to it and how effectively it turns those into revenues compared to its expenses.

This return-on-capital focus gives a more accurate view of how much the division contributes to the company's economic health.

With this measurement approach, managers can decide whether to pump more capital in to boost profits or shut down a department that's inefficiently using its invested capital.

If an investment center can't earn a return on its funds higher than the cost of those funds, it's considered not economically profitable.

Investment Center vs. Cost Center

An investment center stands apart from a cost center, which doesn't directly add to the company's profits and gets evaluated solely on the costs of its operations.

Also, unlike profit centers, investment centers can use capital to buy other assets.

Due to this added complexity, companies rely on various metrics like return on investment (ROI), residual income, and economic value added (EVA) to gauge a department's performance.

For instance, a manager might compare the ROI to the cost of capital; if ROI is 9% but the cost of capital is 13%, that means the investment center is handling its capital or assets poorly.