Profit Center v/s Investment Center

Presented by Sneha Chavan: 08

Cost, Profit, and Investments Centers

Responsibility Centers

Cost Center

Profit Center

Investment Center

Cost Center A segment whose manager has control over costs, but not over revenues or investment funds.

Evaluation . . .
A cost center is evaluated by means of performance reports (i.e., comparison of actual with standard).

Profit Center
A profit center is a subunit that has responsibility of generating revenue and controlling costs. Profit center evaluation techniques include:
Comparison of current year income with a target or budget. Relative performance evaluation compares the center with other similar profit centers.

Responsibility Centers: A Systems Perspective

Input

Process

Output

Profit Center
Control these

Investment Center
An investment center is a subunit that is responsible for generating revenue, controlling costs, and investing in assets. An investment center is charged with earning income consistent with the amount of assets invested in the segment. Most divisions of a company can be treated as either profit centers or investment centers.

Responsibility Centers: A Systems Perspective

Input

Process

Output

Investment Center
Control these

Profit Center Vs. Investment Center

A profit center is focused on profits as measured by the difference between revenues and expenses. An investment center is compared with the assets employed in earning revenues.

Advantages of Profit Centers

Quality of many decisions is improved. Profit consciousness may be enhanced. Measurement of performance is broadened. Managers are freer to use their imagination and initiative. It provides a training ground for general management.

Advantages of Investment Center

save money for your future It is also like an independent business (common when an organization acquires another organization e.g. Sears financial centers). money grows at a good rate when compared to the inflation rate

Disadvantages of Profit Centers

Top management may lose some control. Lack of competent general managers. Disadvantageous competition between organization units. Friction can increase. Too much emphasis on short-run profitability. The quality of some of the decisions may be reduced. Additional costs.

Disadvantages of Investment Center

may lose money if you choose high risk investment options.

The Components of ROI

ROI has a distinct advantage over income as a measure of performance since it considers both income (the numerator) and investment (the denominator).
ROI = Income Invested capital

The Component of RI
Residual Income (RI) overcomes the underinvestment problem of ROI since any investment earning more than the cost of capital will increase residual income.
Residual Income = NOPAT Required Profit

= NOPAT Cost of Capital x Investment

= NOPAT Cost of Capital x (Total Assets Noninterest Bearing Current Liabilities)

Measuring ROI Income and Invested Capital

ROI Income Investment center income will be measured using net operating profit after taxes (NOPAT). NOPAT should exclude nonoperating items such as interest expense and nonoperating gains and losses, net of the tax effect.

ROI Invested Capital Invested capital is measured as total assets less noninterest bearing current liabilities. Noninterest bearing current liabilities are deducted from total assets because they are a free source of funds and reduce the cost of the investment in assets.