An investment center is a business department or function responsible for managing specific revenues, costs, assets, and liabilities. This financial information usually relates to capital investments made in securities, other businesses or the company’s facilities. Larger companies may have multiple investment centers depending on the number of investments and size of their business operations. Managers must often meet specific return on investment percentage as predetermined by company policy.
The return on investment calculation evaluates the efficiency of each investment center project. The basic formula is the gain from individual investments minus the investment cost. This number is then divided by the investment’s cost. The return on investment finance formula is extremely popular in the business environment because it is simple and versatile. Managers can apply this formula to different pieces of financial information, regardless of the investment type. Managers can therefore have an economic indicator to compare various capital investments made by the company.
An investment center can also use other various corporate finance formulas when selecting new business opportunities. While the return on investment measures an investment's historical financial return, it may be ill-applied when attempting to select new investment opportunities. Investment center managers can use the net present value, payback period, or similar corporate finance formulas when selecting new investment opportunities. The net present value calculation estimates all future cash inflows, discounts them back to the current dollar value and compares the total discounted future cash flows to the initial capital investment expenditure. If the cash inflows are higher than the initial cash outflow, companies often see this as a profitable opportunity.
The payback period calculation is a much simpler finance formula. Managers will estimate the future monthly cash inflows from new investment opportunities and divide the initial capital outlay by the small fleet income amount. The resulting number indicates how many months companies will need to operate new opportunities in order to break even and then eventually make profits. The payback period formula is usually seen as less reliable than other corporate finance formulas due to its overly simplistic estimation techniques.
A significant drawback to investment center management is the ability for one individual to manipulate financial information. Managers needing to improve their investment numbers may alter an investment’s financial information in order to increase the rate of return percentage. Classic manipulation techniques include underestimating costs or overestimating the revenues and cash flows. Managers also shift costs from their investments to other business activities. Shifting these costs gives the illusion that investments are achieving estimated returns.
