Definition: The investment center return on total assets ratio, also called return on investment, is a profitability ratio that compares a department’s profits with the total assets required to generate those profits. In other words, it’s a financial ratio that is used by management to analyze the performance of each investment center based on their relative level of capital.
What Does Investment Center Return on Total Assets Mean?
The investment center return on total assets formula is calculated by dividing the net income from the department by the average total assets for the period. Average total assets are usually computed for the year by simply adding the beginning and ending balances and dividing by two.
This simple ratio helps management evaluate and compare departments based on their relative return. For example, it would be unfair to compare an investment centers’ profits of one with $10M of revenues with one that $100,000 of revenues. These two departments are completely different sizes and can’t be directly compared with raw numbers. Financial ratios have to be used. The investment center return ratio shows how well each center uses its assets and allows management to compare large and small departments based on their efficiencies.
Management might find out that a smaller department that produces fewer profits is actually using its capital more effectively and efficiently than a larger department. Thus, they might decide to reduce the invested capital in the larger department and increase the invested capital in the smaller department.
Executives and top-level management often use this ratio to not only evaluate the performance of an individual department, they also use it judge how well the management in that department uses the assets to generate revenues and runs the investment center. Based on this performance information, top-level management often decides where to assign managers and what departments need to change leadership.