In an investment center, the manager is responsible for profit generation and is also in a position to make decisions related to a company’s economic resources. The evaluation of an investment center is based on revenues, expenses, as well as assets, debt and equity decisions. An investment center typically has its own financial statements, comprised of at least an income statement and balance sheet.
The investment center is the highest level of management of the various methods of reporting the results of a business, since it encompasses all financial activities of the organization, segment or division. An example of the manager of an investment center would include the President of Harley Davidson.
We will use the information from The Unknown Comic, Inc. to show the calculations. The following information was provided by the company:
| Operating income | $54,950 |
| Average total assets | $196,000 |
| Net sales | $214,200 |
| Required rate of return | 20% |
Operating income and net sales came from our flexible budget performance in this lesson. The average total assets came from our 2016 and 2017 balance sheets and the required rate of return was provided by management.
We will calculate the following: NOTE: Ratios may vary slightly from textbook!
Return on investment = operating income / average total assets
Return on investment = $54,950 / $196,000
Return on investment = 28.0%
Profit margin = operating income / net sales
Profit margin = $54,950 / $214,200
Profit margin = 25.7%
Asset turnover = net sales / average total assets
Asset turnover = $214,200 / $196,000
Asset turnover = 1.1 times
Step 1, calculate minimum acceptable operating income:
Minimum acceptable operating income = target rate of return x average total assets
Minimum acceptable operating income = 20% x $196,000
Minimum acceptable operating income = $39,200
Step 2, calculate residual income:
Residual income = operating income - minimum acceptable operating income
Residual income = $54,950 - $39,200
Residual income = $15,750
We will use this information as part of the evaluation of the overall performance of the company. We will compare the results calculated with company estimates for the year. We will compare these results with results of past years for our company to see if there are any significant trends that need to be addressed. We will also compare our results with the results for our industry and our key competitors.