Everything you need to know about investment centers [explained by a Certified Accountant]

What Is an Investment Center?

Investment center is an autonomous unit within an organization that is responsible for generating its own revenue as well as controlling the costs and assets used by the segment, whose performance is measured based on how it utilizes the capital employed to contribute to the entity’s profitability.

Investment centers have 3 main characteristics:

  • 1. Independence

Investment center is a standalone business segment accountable for its own assets, expenses and revenues.

  • 2. Profit

The objective of an investment center is to use capital employed to contribute to the profitability of its parent company.

  • 3. Return on Investment

The performance of an investment center is evaluated on the basis of the return earned on invested capital.

Examples of Investment Centers

The most common examples of investment centres are company subsidiaries and divisions separated from one another by function, location, product group or service type.

Although an investment center can be any business segment that is in charge of its own revenues, expenses and assets, the categorization is particularly useful when an entity makes a relatively large investment in terms of working capital or fixed assets into an organizational unit.

The concept of investment centers can be applied to independent segments of both large corporations and smaller companies.

To the outside eye, the individual investment centers may seem like separate companies, even though they in fact belong to the same entity.

Real-life Example: Colgate-Palmolive

As a real-life example, the annual report of Colgate-Palmolive Company states that the multinational corporation manufactures and markets a wide variety of products in 2 main product segments and 5 geographical segments:

Colgate-Palmolive 2 Product Segments

1. Oral, Personal and Home Care
  • Oral Care
  • Toothpaste, toothbrush and mouthwash brands: Colgate, Darlie, elmex, meridol
  • Personal Care
  • Shower gel, liquid and bar soap brands: Protex, Sanex, Softsoap, Irish Spring, Palmolive
  • Deodorant and antiperspirant brands: Lady Speed Stick, Sanex, Speed Stick, Tom’s of Maine
  • Skin health brands: EltaMD, Filorga, PCA Skin
  • Shampoo and conditioner brands: Palmolive
  • Home Care
  • Dishwashing liquid brands: Ajax, Axion, Palmolive
  • Household cleaner brands: Ajax, Fabuloso, Murphy
  • Fabric conditioner brands: Suavitel (Latin America), Soupline (Europe), Cuddly (South Pacific)
2. Pet Nutrition
  • Everyday nutritional needs: Hill’s Science Diet (Hill’s Science Plan in Europe)
  • Therapeutic nutrition to manage disease conditions: Hill’s Prescription Diet
3. Corporate

In addition, the company has a Corporate segment, which primarily consists of financial investments, such as equity securities or derivative instruments.

Colgate-Palmolive 5 Geographical Segments

While the company is present in over 80 countries and territories around the world, the operations of the product segments are managed geographically in 5 reportable operating segments:

  1. North America
  2. Latin America
  3. Europe
  4. Asia Pacific
  5. Africa/Eurasia

If these business segments of the Colgate-Palmolive Company operate as autonomous units with their management being responsible for the revenues generated, costs incurred and assets employed, then they could be labeled as investment centers.

How to Evaluate Investment Centre Performance?

The financial performance of an investment center is judged based on the return on assets invested in that specific business unit to measure how well it utilizes its capital to contribute to the overall bottom line of a business.

This is because an investment center is typically used when a business makes a significant investment in the assets of a subunit that has been delegated the responsibility for its own revenue, expenses, and the assets invested in the center.

The financial indicators commonly used to calculate how well an investment center is performing in terms of the return earned on the invested capital include:

  • Return on investment (ROI) – earnings divided by investment
  • Residual income (RI) – earnings minus expected target return
  • Economic value added (EVA) – after-tax earnings minus cost of capital
  • Return on capital employed (ROCE) – earnings divided by capital employed

For internal accounting purposes, investment center is typically treated as a separate reporting entity with its own financial statements, which are then consolidated into the parent entity’s external reports.

Investment Center vs. Profit Center

The difference between a profit center and an investment center is that a profit center is a responsibility center whose performance is measured only based on the profits it generates, whereas investment center is evaluated based on its use of capital and return on investment.

In other words, an investment center is an extended profit center in which not only revenues and expenses are measured, but also the return earned on assets and invested capital.

Investment Center vs. Cost Center

The difference between a cost center and an investment center is that the performance of a cost center is measured based on the costs it incurs to run its operations, whereas an investment center is evaluated according to return on investment as it is responsible for its costs, revenues and assets.

In a cost center, the focus is on minimizing costs, which may not directly contribute to a company’s profitability.

In contrast, the management of an investment center is focused on maximizing the return on assets and capital employed in the business segment.

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