As opposed to an investment centre, which is a division or branch of a firm with responsibility for revenue and cost decisions, a profit centre is also tasked with making investment decisions, which makes it a separate legal entity from the company’s other departments and branches. Profit centres and investment centres are examples of operational units that should be selected by a company’s top management. When comparing an investment centre to a profit centre, top management interference is substantially lower in the investment centre, where divisional managers enjoy greater divisional autonomy.
In Business, a Profit Centre Is a Strategic Location Where Profits Are Generated
If a profit centre is a separate business entity, it is a division of the corporation. The managers of a profit centre are often in charge of making decisions about the product, price, and operational expenses. All revenue and expenditure decisions, except investments, are made by managers in a profit centre.
Top executives at the company’s headquarters make investment decisions, such as whether to buy or sell company assets. Comparing results between profit centres makes it easier for the top management to determine how much each profit centre adds to the company’s bottom line.
The JKT Company, for example, is an international cosmetics manufacturer. JKT has offices in more than 20 countries. Manufacturing facilities for cosmetics may be found in all but two of the world’s countries. The divisional managers are responsible for all revenue and cost decisions in their respective nations’ operations.
What Exactly Is an Investment Centre, and How Does It Work?
In addition to revenue and cost-related decisions, an investment centre serves as a profit centre to make investments. Business divisions that can directly impact a company’s profits are known as investment centres.
Investing in long-term survival requires businesses to make a variety of decisions. Purchase, improvement, and disposal of capital assets are among these decisions. As a continuation of the last example, here is an example.
For example, divisional managers at JKT have the authority to decide which new capital assets to acquire, which ones to modernise, and which ones to dispose of, in addition to making decisions on revenues and expenditures.
An investment centre’s primary evaluation criterion is how much revenue it generates as a percentage of its capital asset investment. An investment centre’s performance can be assessed using any or all of the following financial measures.
- Investment Payback (ROI)
- Return on Investment (ROI) is a method of determining how much money is made compared to the amount of money invested.
- Return on Investment (ROI) is calculated as follows: EBIT / Capital Employed
- Continual Earnings (RI)
A finance charge is deducted from earnings to show how assets are being used in the calculation of RI, which is typically used to evaluate the success of company divisions. The RI calculation formula is, Return on Assets (ROA) is the difference between the revenue generated by the operating assets and the cost of capital.
Additional Economic Benefits (EVA)
Financial charges are deducted from earnings to show the utilisation of assets in the EVA performance metric used to evaluate the performance of business divisions. To compute EVA,
- (NOPAT – Cost of capital) – (Operating Assets*Cost of capital)
- Discernment between a Profit Center and a Center for Investment
- Figure 1 depicts an investment centre’s decision-making process.
Is There a Distinction Between a Profit Centre and an Investment Centre, for Example?
- Investment vs. Profit Center
- An independent profit centre is a firm division that is responsible for making revenue and cost choices on its own.
- As well as income and expense decisions, the investment centre is responsible for making investments.
- Capital Assets Decisions
- Top executives at the company’s headquarters make decisions about profit centre capital assets.
- Divisional managers in investment centres make the decisions on capital assets.
Sector Managers Have Their Independence
Because they are not allowed to make investment decisions, profit centre divisional managers have less autonomy than investment centre managers. Managers of the investment centre division have a great degree of autonomy because they are allowed to make investment decisions.
The Bottom Line Is This
Investment vs. Profit Center
The fundamental distinction between profit centres and investment centres is whether or not the top management at corporate headquarters (in profit centres) or the divisional managers in the particular business entity (in investment centres) take the choices regarding capital asset purchases and sales (in investment centres).
Managers in investment centres may be more driven than their counterparts in profit centres because of the power and responsibility that comes with decision-making authority. Whether to organise business units as profit centres or investment centres generally depends on the mindset of the senior management, the nature of the firm and industry practices.
While profit centres focus on how much money they make, investment centres focus on how much money they make on the fixed assets or working capital they invest in.
Unlike a profit centre, an investment centre could invest in activities and assets that are not necessarily related to the company’s operations. Diversification of the company’s risk may be achieved through investments in or acquisitions of other enterprises. There is a new trend in the establishment of venture arms within existing firms to enable investments in the next wave of trends through acquisitions of startup stakes
Departmental performance is evaluated by looking at how much money a department generates and how much money it spends, as compared to the number of assets and resources it has. The investment centre philosophy presents a more accurate view of how a division contributes to the company’s financial health by focusing on return on capital.
With this method of analysing the efficiency of a department, managers can determine whether or not capital should be increased to boost profits or whether a department should be closed down because it is wasting its invested capital. An investment centre that does not earn a return on invested money over the cost of such assets is considered to be unprofitable.
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