Everything you need to know about investment centers [explained by a Certified Accountant]
Investment centers have 3 main characteristics:
Investment center is a standalone business segment accountable for its own assets, expenses and revenues.
The objective of an investment center is to use capital employed to contribute to the profitability of its parent company.
The performance of an investment center is evaluated on the basis of the return earned on invested capital.
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.
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:
In addition, the company has a Corporate segment, which primarily consists of financial investments, such as equity securities or derivative instruments.
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:
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.
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:
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.
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.
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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