How is performance generally measured in cost center profit center investment center?
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Obviously most business units incur costs, so this alone does not define a cost center. A cost center is perhaps better defined by what is lacking; the absence of revenue, or at least the absence of control over revenue generation. Human resources, accounting, legal, and other administrative departments are expensive to support and do not directly contribute to revenue generation. Cost centers are also present on the factory floor. Maintenance and
engineering fall into this category. Many businesses also consider the actual manufacturing process to be a cost center even though a saleable product is produced (the sales "responsibility" is shouldered by other units). It stands to reason that assessments of cost control are key in evaluating the performance of cost centers. This chapter will show how standard costs and variance analysis can be used to pinpoint areas where performance is above or below expectation. Cost control should
not be confused with cost minimization. It is easy to reduce costs to the point of destroying enterprise effectiveness. The goal is to control costs while maintaining enterprise effectiveness. Nonfinancial metrics are also useful in monitoring cost centers: documents processed, error rates, customer satisfaction surveys, and other similar measures can be used. The concept of a balanced scorecard is discussed later in this chapter, and it can be very relevant to evaluating the performance
of a cost center. Some business units have control over both costs and revenues and are therefore evaluated on their profit outcomes. For such profit centers, "cost overruns" are expected if they are coupled with commensurate gains in revenue and profitability. A restaurant chain may evaluate each store as a separate profit center. The store manager is responsible for the store's revenues and expenses. A store with more revenue would obviously generate
more food costs; an assessment of food cost alone would be foolhardy without giving consideration to the store's revenues. For such profit centers, the flexible budgets discussed in this chapter are particularly useful evaluative tools. Other metrics include unit-by-unit profitability analysis using ratio tools introduced in the financial analysis chapter. At higher levels within an organization, unit managers will be held accountable not only for cost
control and profit outcomes, but also for the amount of investment capital that is deployed to achieve those outcomes. In other words, the manager is responsible for adopting strategies that generate solid returns on the capital they are entrusted to deploy. Evaluation models for investment centers become more complex and diverse. They usually revolve around various calculated rates of return. One popular method was pioneered by E.I. du Pont de Nemours and Company. It is commonly known as
the DuPont return on investment (ROI) model, and is pictured at right. This model consists of a margin subcomponent (Operating Income/Sales) and a turnover subcomponent (Sales/Average Assets). These two subcomponents can be multiplied to arrive at the ROI. Thus, ROI = (Operating Income/Sales) x (Sales/Average Assets). A bit of algebra reveals that ROI reduces to a much simpler formula: Operating Income/ Average Assets. But, a prudent manager who is to be evaluated under
the ROI model will quickly realize that the subcomponents are important. Notice that ROI can be increased by any of the following actions: increasing sales, reducing expenses, and/or decreasing the deployed assets. The DuPont approach encourages managers to focus on increasing sales, while controlling costs and being mindful of the amount invested in productive assets. A disadvantage of the ROI approach is that some "profitable" opportunities may be passed by managers because they fear potential
dilution of existing successful endeavors. The consulting firm of Stern, Stewart & Co. has trademarked and popularized the Economic Value Added model as an alternative comprehensive evaluative tool for assessing investment returns. Presumably, it compensates for the deficiencies of simpler models. Advanced managerial accounting courses typically devote considerable coverage to the various approaches to evaluating investment centers. Profitability is the backbone of any business. However, not every section of the company is involved in the direct generation of revenues. Some are classified as costs but support the functioning of the company. Others are involved in assets while others are not. Companies that have learned the secret have separated their businesses into segments to maximize these segments’ strengths. For example, companies have profit centers, cost centers, and investment centers which could all be in the same location but operating separately. In this article, let’s find out the differences between profit centers and investment centers. Profit CenterA Profit Center refers to a branch of a company that directly contributes to the entire organization’s earnings. It is generally treated as a separate entity responsible for generating its income. The profits and losses from this center are calculated independently from other areas of the company. The term profit center was introduced in 1945 by Peter Drucker. Profit centers are important to ascertain which areas of a business are more or less profitable than others. For cross-comparison and more accurate analysis, they differentiate between certain revenue-generating activities. The analysis helps in determining the future allocation of available resources. It also helps determine if some activities should be cut completely. The profit center manager is help responsible for both revenue and costs, and hence profit. The manager is held accountable to drive sales income-generating activities leading to cash inflows as he manages the cost-generating tasks. Profit center management is thus more challenging than managing a cost center. The managers in profit centers have authority to make decisions regarding product prices and operating costs. They also experience a lot of pressure to ensure that their division gives profit year by year, meaning the sales must outweigh the costs. This can be done either by increasing revenue, decreasing expenses, or both. Examples of profit centers include a store or a sales organization whose profitability is measurable.  Investment CenterAn investment center is a business unit that uses capital to contribute to the profitability of a company. The performance of an investment center is evaluated by the revenues it brings in through investments in assets in comparison to the overall expenses. It is sometimes referred to as an investment division. It’s a center that is responsible for its revenue, expenses, and assets while managing its financial statements. The financial statements are ideally a balance sheet and an income statement. The investment center prioritizes offering returns on assets invested mainly in the investment center. The center might also invest in activities and assets that are not necessarily related to the company’s operation. This could include investments in other companies which diversifies the company’s risk. An investment center most likely is a subsidiary company or division because costs, revenues, and assets have to be identified separately. It can usually be termed as an extension of the profit center where income and costs are measured. The difference is that it’s only in an investment center that assets employed are also measured and compared to the profits made. An example of an investment center is the financing arm of an automobile maker or department store. Investment centers are beneficial to companies as financialization causes companies to seek profits from investments and lending to add to the overall production. The manager of an investment center is in control over the investments this center has to bring profits to the department. Similarities between Profit Center and Investment Center
Differences between Profit Center and Investment CenterDefinitionA Profit Center refers to a branch of a company that directly contributes to the entire organization’s earnings. It is generally treated as a separate entity responsible for generating its income. On the other hand, an investment center is a business unit that uses capital to directly contribute to the profitability of a company. It is responsible for its revenue, expenses, and assets while managing its financial statements. Decisions on Asset CapitalDecisions about capital assets in profit centers are taken up by top officials in corporate headquarters while in investment centers the decisions are made by divisional managers in the investment centers. Authority of divisional managersThe divisional managers in profit centers have less autonomy than in investment centers as they cannot make investment decisions. Divisional managers in investment centers have a high level of autonomy as they are authorized to make investment decisions. Profit Center vs. Investment Center: Comparison TableProfit Center vs. Investment Center: ConclusionA profit center refers to a branch of a company that directly contributes to the entire organization’s earnings. It is generally treated as a separate entity responsible for generating its income. Investment Center refers to a center that is responsible for its revenue, expenses, and assets while managing its financial statements. Now you know. FAQS:What is a cost-profit and investment center?It’s a center that has the three centers combined. It has a segment that is responsible for the generation of revenues (profit), another that does not generate its income but supports the center (cost), and another that deals with assets and is responsible for its costs and profits while managing its financial statements. What is meant by investment center?It’s a center that is responsible for its revenue, expenses, and assets while managing its financial statements. What are profit centers?A Profit Center refers to a branch of a company that directly contributes to the entire organization’s earnings.
Tabitha graduated from Jomo Kenyatta University of Agriculture and Technology with a Bachelor’s Degree in Commerce, whereby she specialized in Finance. She has had the pleasure of working with various organizations and garnered expertise in business management, business administration, accounting, finance operations, and digital marketing. Loading... Cite How is performance in a cost center generally measured?The performance of a cost center is usually evaluated through the comparison of budgeted to actual costs. The costs incurred by a cost center may be aggregated into a cost pool and allocated to other business units, if the cost center performs services for the other business units.
How performance is measured in profit centre?Performance measures for cost centres include:
Profit per unit: because a profit centre manager is responsible for costs and revenues, profit per unit produced or supplied is an obvious measure. A simple way to calculate this is to divide the profit for a period by the units produced in the period.
How the performance of investment Centres are measured in an Organisation?These are two important and popular methods of measuring investment centre performance. They are Return on Investment (ROI) and Residual Income (RI). Net operating investment may be in terms of written down value or the gross value of the fixed assets.
What are the three measures of investment center performance?Three common measures used to evaluate the performance of investment centers are return on investment (ROI), residual income (RI), and extra value added (EVA).
What is cost center profit center and investment center?A segment responsible only for costs is called a cost center. A segment responsible for costs and revenues is called a profit center. A segment responsible for costs, revenues, and investment in assets is called an investment center.
What is an investment center and how is its performance evaluated?An investment center is an organizational unit responsible to top management for its profitability in relation to the unit's own investment base. Revenues and expenses are measured as in profit centers, but the assets employed are also measured.
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