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An investment center manages revenues, costs, assets, and liabilities of a company’s investments, using formulas such as ROI, net present value, and payback period to evaluate opportunities. However, managers may manipulate financial information to improve investment numbers.
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 the company’s securities, other assets or facilities. Larger companies may have multiple investment centers depending on the number of investments and the size of their business operations. Managers are often required to meet a specific return on investment percentage, as predetermined by company policy.
The ROI calculation evaluates the efficiency of each investment center project. The basic formula is the return on individual investments minus the cost of the investment. This number is then divided by the cost of the investment. The return on investment formula is extremely popular in the corporate environment because it is simple and versatile. Managers can apply this formula to a variety of financial pieces of information, regardless of investment type. Managers can then have an economic indicator to compare the various capital investments made by the company.
An investment center may also use other various corporate finance formulas when selecting new business opportunities. While return on investment measures the historical financial performance of an investment, it can be misapplied when trying to screen for new investment opportunities. Investment center managers may use net present value, repayment term, or similar corporate finance formulas when selecting new investment opportunities. The net present value calculation estimates all future cash inflows, discounts them back to present dollar value, and compares the total discounted future cash flows to the initial capital investments. If cash inflows are greater than the initial cash outflow, companies often see this as a profitable opportunity.
Payback period calculation is a much simpler financial formula. Managers will estimate 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 exploit new opportunities to break even and ultimately make a profit. The payback period formula is generally considered to be less reliable than other corporate finance formulas due to its overly simplistic estimating techniques.
A significant drawback to investment center management is an individual’s ability to manipulate financial information. Managers who need to improve their number of investments can change the financial information of an investment in order to increase the percentage rate of return. Classic manipulation techniques include underestimating costs or overestimating revenues and cash flows. Managers also shift costs from their investments to other business activities. The shifting of these costs gives the illusion that investments are achieving estimated returns.
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