Difference Between Profit Center and Investment Center

Key Difference – Profit Center vs Investment Center
 

The key difference between a profit center and investment center is that a profit center is a division or a branch of a company which is considered to be a standalone entity that is responsible for making revenue and cost related decisions whereas an investment center is a profit center that is responsible for making investment decisions in addition to revenue and cost related decisions. Selection of operating entities such as profit centers or investment centers is a decision that should be made by the top management of a company. Top management intervention in an investment center is significantly low compared to a profit center where divisional managers in an investment center have more divisional autonomy than managers in a profit center.

CONTENTS
1. Overview and Key Difference
2. What is a Profit Center
3. What is an Investment Center
4. Side by Side Comparison – Profit Center vs Investment Center
5. Summary

What is a Profit Center?

A profit center is a division or a branch of a company that is considered to be a standalone entity. A profit center is responsible for generating its own results where the managers generally have decision-making authority related to the product, pricing, and operating expenses. Managers in a profit center are involved in all decisions relating to revenues and costs, except for investments. Decisions regarding investments such as acquiring or disposing capital assets are taken by the top management in corporate headquarters. Having profits centers makes it convenient for the top management to compare results and to identify to what extent each profit center contributes to corporate profits.

E.g. JKT Company is a multinational company that produces high-end cosmetic products. JKT operates in 20 countries around the world. Cosmetics are produced in manufacturing plants located in all 20 countries. Each operation in respective countries is operated as profit centers where the divisional managers are responsible for all revenue and cost related decisions.

The concept of profit centers enables the company’s management to decide how best to allocate its resources to maximize profitability by,

• Allocating more resources to high profit making entities
• Improve the performance of loss-making units
• Discontinue entities that do not have future potential

What is an Investment Centre?

An investment center is a profit center that is responsible for making investment decisions in addition to revenue and cost related decisions. Investment centers are business units that can utilize capital to directly contribute to a company’s profitability. Businesses have to make various decisions regarding investing in capital assets that enable long-term viability. These include decisions to purchase, dispose and upgrade capital assets. Continuing from the same example,

E.g. In addition to decisions regarding revenues and costs, divisional managers in JKT have the authority to decide which new capital assets to purchase, which ones should be upgraded and the ones that should be disposed.

The main evaluation criterion for an investment center is to assess how much revenue it generates as a proportion of its investment in capital assets. Companies can use one or a combination of the following financial metrics to evaluate the performance of an investment center.

Return on Investment (ROI)

ROI allows calculating how much returns are made compared to the amount of capital invested and calculated as,

ROI = Earnings before interest and tax (EBIT)/ Capital Employed

Residual Income (RI)

RI is a performance measure normally used to assess the performance of business divisions, in which a finance charge is deducted from the profits to indicate the usage of assets. Formula for calculating RI is,

Residual Income = Net Operating Profit – (Operating Assets* Cost of Capital)

Economic Value Added (EVA)

EVA is a performance measure normally used to assess the performance of business divisions, in which a finance charge is deducted from the profits to indicate the usage of assets. EVA is calculated as,

EVA = Net operating profit after tax (NOPAT) – (Operating assets* Cost of capital)

What is the difference between Profit Center and Investment Center?

Summary – Profit Center vs Investment Center

The key difference between profit center and investment center mainly depends on whether the decisions regarding purchase and disposal of capital assets are taken by the top management at corporate headquarters (in profit centers) or by divisional managers in the respective business entity (in investment centers). Divisional managers in investment centers may be highly motivated than managers in profit centers due to their authority in decision making. Whether to operate business units as profit centers or investment centers often depends on the attitude of the top management, nature of the business and industry practices.

References
1. “Profit Center.” Investopedia. N.p., 29 July 2015. Web. 12 Apr. 2017.
2. “Investment Center.” Investopedia. N.p., 26 June 2011. Web. 12 Apr. 2017
3. “Divisional performance measures (ROI, RI and EVA®).” Help for ACCA AND CIMA Studies (Also useful to B.COM, CA,ICWAI,CS, M.COM,M.B.A). N.p., n.d. Web. 12 Apr. 2017.