Administrating a company is a task that demands a lot of knowledge, proficiency and dedication, because a business owner needs to be aware of countless elements that require a high degree of specialization to be applied correctly. An important resource that positively changes the revenues and financial efficiency of an organization is how to calculate its ROI per cost center.
Many entrepreneurs and managers don’t know these concepts, but those that do have the keys in their hands to place their companies ahead of their competitors and transform them into market leaders. In this guide, we’ll show you all you need to know about this subject, the concepts of cost centers and ROI and how to calculate it. Keep reading!
What is a cost center?
Cost and profit centers are company departments with relative autonomy, which have their own financial administration which isolates their revenues and expenses from the rest of the company. These segments can be administration, sales, production, advertising, and finance among others.
This form of organization allows the separate collection of data from each part of the entity. With this information, you’ll have better financial control of that department, because the investments and decisions regarding the reallocation of resources will be adapted according to what is best for that area.
Another advantage consists of minimizing errors in controlling revenues and expenses, because the costs will be analyzed by professionals who specialize in the activities of this department, and therefore they can identify possible reductions in spending and potential increases in productivity.
What is ROI?
ROI signifies Return over Investment. As the name itself indicates, this is a metric that indicates the return on the financial investments made by the company, showing whether each one has resulted in a profit or loss.
This indicator is applicable for any profitable activity, such as worker training, the acquisition of tools, the adoption of new strategies, marketing campaigns, etc. Through ROI it’s possible to analyze whether your money is in the right investments, and it is an essential instrument in orienting decision making by managers.
How do you calculate ROI?
The formula of ROI is simple and involves few factors, and it can be computed quickly. The equation is as follows:
ROI = (obtained gains – investment cost) /investment cost
The obtained gain consists of the amount generated by the applied capital, while the investment cost is made up of the investment value, including all of the expenses necessary to make it. Next take a look at the purely illustrative example of how to apply this formula in practice:
ROI = (300,000 – 100,000) / 100,000
ROI = 2
After making this calculation, multiply the value by 100 to obtain the relative percentage for the return over investment. In this case the gains were 200% over the initial value.
How do you calculate ROI per cost center?
The more segmented the company departments are, the better the applied ROI will be, because it will be possible to verify how much each investment in every department is giving the company. The managers will identify, in an exact and precise manner, where they should focus their financial efforts and cut the investments that are resulting in losses.
In addition, you can calculate the ROI per cost center in a general manner. If a department is generating losses, the administrators will have to study measures to revert the situation of this specific department.
Calculating the ROI per cost center is an essential act for companies in achieving their budget targets, because a department or part of it may be reducing the profitability of a company without the controller being aware of it. However, after reading this article, you now know how to detect loss making or barely profitable investments in each center and can reallocate the company’s resources to leverage its rate of return.
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