Cost Centre Profit Centre

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- A cost center is part of an organization that does not produce direct profit and adds to the cost of running a company. Examples of cost centers include research and development departments, marketing departments, help desks and customer service/contact centers.
Although not always demonstrably profitable, a cost center typically adds to revenue indirectly or fulfills some other corporate mandate. Money spent on research and development, for example, may yield innovations that will be profitable in the future. Investments in public relations and customer service may result in more customers and increased customer loyalty.
Because the cost center has a negative impact on profit (at least on the surface) it is a likely target for rollbacks and layoffs when budgets are cut. Operational decisions in a contact center, for example, are typically driven by cost considerations. Financial investments in new equipment, technology and staff are often difficult to justify to management because indirect profitability is hard to translate to bottom-line figures.
Business metrics are sometimes employed to quantify the benefits of a cost center and relate costs and benefits to those of the organization as a whole. In a contact center, for example, metrics such as average handle time, service level and cost per call are used in conjunction with other calculations to justify current or improved funding.
Cost centres are divisions that add to the cost of the organization, but only indirectly add to the profit of the company. Typical examples include Research and Development, Marketing and Customer service.
Companies may choose to classify business units as cost centres, profit centres, or investment centres. There are some significant advantages to classifying simple, straightforward divisions as cost centres, since cost is easy to measure. However, cost centres create incentives for managers to underfund their units in order to benefit themselves, and this underfunding may result in adverse consequences for the company as a whole (reduced sales because of bad customer service experiences, for example).
Because the cost centre has a negative impact on profit (at least on the surface) it is a likely target for rollbacks and layoffs when budgets are cut. Operational decisions in a contact centre, for example, are typically driven by cost considerations. Financial investments in new equipment, technology and staff are often difficult to justify to management because indirect profitability is hard to translate to bottom-line figures.
Business metrics are sometimes employed to quantify the benefits of a cost centre and relate costs and benefits to those of the organization as a whole. In a contact centre, for example, metrics such as average handle time, service level and cost per call are used in conjunction with other calculations to justify current or improved funding.
Profit Centers are parts of a Corporation that directly add to its Profit.
Managers are held accountable for both revenues, and costs (expenses), and therefore, profits.
Usually the different profit centers are separated for Accounting purposes so that the management can follow how much profit each center makes and compare their relative efficiency and profit. Examples of typical profit centers are a store, a sales organization and a consulting organization. Profit centers can measure profitability of business units or departments.
So What ... Is A Profit Center?




In many senses, a farm is like a tractor. If all of the components are tuned and in good working order, you get good (fuel) efficiency, power when you need it, and long lasting performance.

Although you judge the tractor on its overall ability to do the jobs you have at hand, you still monitor and fine tune each of the components to ensure they’re operating up to acceptable standards, contributing to overall performance.
So what does this have to do with "profit centers"? Like the tractor, you have expectations of your farm’s performance. These are judged on:
ability to generate sufficient cash flow to meet your living needs,
a longer term expectation of asset growth and return on assets comparable with non-farm investment options, and
some degree of "certainty" in both of the above, ie. although there will be lean years, you try to have these balanced off, in the long haul, by good years.
Your judgement happens at the farm level, considering all of the commodities you produce. However, to meet your expectations, the "fine tuning" you do on your farm is on each of your component enterprises, or profit centers. Simply defined, a profit center is a production activity focused on creating:
a commodity for final sale, or
a product for use in one of your other farm profit centers.
For example, as a cow/calf operator, you likely have in addition to your cow herd (selling weaned calves), a forage enterprise (raising feed for your herd and to sell) and a pasture profit center (raising grazing "dry matter" to support your herd). So what do these profit centers have to do with managing your cow herd and your farm? Many producers consider these three enterprises as one business. By taking the profit center approach, you can focus on ensuring each is performing at an "economic optimum" and making a positive contribution to your farm’s bottom line. By managing each enterprise as a business within your farm, your analysis, planning and decision making is more focused. You’ll make better production and management decisions about each of your profit centers, and improve your farm’s ability to meet the three basic expectations noted earlier.
Grouping all of your activities together allows a poor economic performer to hide behind good performance elsewhere. Peter can rob Paul. By taking the profit center approach, you:
get clarity of management information,
can readily identify operational strengths and weaknesses,
can plan and implement direct action to improve productivity and efficiency,
can identify and cull "dead weight", inefficient activities that consistently draw on the farm’s bottom line, and
can value activities that may only break even over time but reduce risk in input supply at an acceptable price or cost (eg. feed).
Every product you raise has a market value. If you use it in one of your other enterprises, cost it in at this value. When you build your farm income statement at the end of the day, all of these non-cash transfers are washed out but you’re left with the message as to how each of your profit centers has contributed to your overall profit. Going back to our example, I’ll pose a couple of pointed questions:
if you can’t make money raising and selling hay, should you ask your cows to essentially pay more than market value for feeds?
if you can raise hay in a profitable manner, but your cows are "hay-burners", should you be "giving" the hay to the cows at cost and making them look better than they really are?
These questions may be simplistic but they do highlight the importance of assessing each of the building blocks on your farm.

PROFIT CENTER
A profit center is a unit of a company that generates revenue in excess of its expenses. It is expected that, through the sale of goods or services, the unit will turn a profit. This is in contrast to a cost center, which is a unit inside a company that generates expenses with no responsibility for creating revenue. The only expectation a cost center has is to lower expenses whenever possible while staying with a specific budget that is determined at the corporate level.
Beyond that simple definition, the term "profit center" has also come to represent a form of management accounting that is organized around the profit center concept. Companies that have adopted the profit center system have organized all of their business units as either profit centers or cost centers, and all company financial results are reported in that manner. Adopting a profit center system often requires a radical shift in corporate philosophy and culture, but it can yield great returns in net before tax (NBT) profits. According to an article in Business Solutions, the data collection company Data Recognition, Inc. made the shift to a profit center-based system and was pleased with the results. "We saw the importance of evaluating, individually, areas of our business that are distinctly different," said Steve Terry, the company's vice president of systems. "The profit centers have allowed us to better identify specific gains and losses. And that's critically important for a growing business."
All companies, no matter what size, have both cost and profit centers (although, if it is a single-person company, that company would really have profit and cost activities, since all business "units" are the same person). For example, in most companies, units such as human resources and purchasing are strictly cost centers. The company has to spend money to operate those units, and neither has any means of producing a profit to offset those expenses. They exist solely to make it possible for other areas of the company to make money. However, without those two departments, the company could not survive. Examples of profit centers would be the manufacturing units that produce products for sale to consumers or other businesses. The sale of those products generates a profit that offsets the expense of creating the products.
All companies have profit centers and cost centers, but not all companies organize their accounting practices around the profit center concept. In fact, most companies do things the time-honored way, producing overall profit and loss statements for the company as a whole, without making each business unit accountable for generating a profit.
TURNING A COST CENTER INTO A PROFIT CENTER
A cost center may actually provide services that could generate a profit if they were offered on the open market. But in most corporate environments, cost centers are not expected to generate a profit and operation costs are treated as overhead. Departments that are typically cost centers include information technology, human resources, accounting, and others. However, the complacent acceptance that some departments will always be cost centers and can never generate a profit has changed at some companies. They recognize that cost centers can turn into profit centers by taking the services they used to automatically provide to the company's other business units and making those services available for a fee. The company's other business units are then required to pay for the services they used to get for free. But in return, they are allowed to go outside the company and contract with another firm to provide those services. Likewise, the former cost center may be allowed to sell its services to other companies. The expectation is that this free market system will improve performance through increased competition while increasing profits by turning former cost centers into profit centers.
"When a business firm becomes a corporate community of entrepreneurs who buy, sell, and launch new products and services internally as well as externally, it gains the same creative interplay that makes market economies so advantageous," said management professor William E. Halal when discussing making the move to profit center-based operations in USA Today Magazine.
As an example of how a cost center may be turned into a profit center, consider a company's information technology (IT) department. This department may provide such services as computer-aided design, network administration, or database development to other units of the company. These services have value, and they are important to the company's overall success, but they do not generate a profit. IT may charge the "cost" of its services back to the department that requested them, but it does not make a profit because it charges only for its actual costs incurred, without adding an extra margin for profit. The unit that requested the services absorbs the cost as part of its overhead; or, in some companies, the cost is not charged back and is simply part of the company's overall overhead.
There are two ways that the IT department could make the switch from cost center to profit center. First, instead of writing off its services to overhead or charging them at cost, the IT department could be allowed to bill other departments for its services at going market rates. The profit earned for the services would exceed the cost of providing the services. While all the money in this transaction would stay within the company, thus making it seem to be a meaningless way of creating a profit for the IT department, it is done for two reasons. One is to ensure that the IT department remains competitive with outside vendors providing the same services, and the other is to ensure that the company's other business units do not waste money on needless IT expenditures. Paying competitive market rates prevents the operating units from wasting money, thus making them more competitive.
If the IT department is turned into that type of profit center, it is considered to be a "zero profit center." In that situation, the department is expected to compete with outside vendors for the company's information technology budget. If a division of the company selects the IT department as its technology provider, it has done so because it feels it cannot purchase the same quality services for a lower price from an outside vendor. It will not actually "pay" the IT department for its services, but it will be charged by the IT department for services rendered, and those charges will be subtracted from the division's budget. Thus, the IT department does not really take in any revenue, but neither does it cost the company any money because the division that utilized its services would have had to spend money to hire an outside vendor. This, then, creates a zero profit center. Such a business model forces the IT department to be more competitive in its pricing and to provide high quality work if it hopes to survive as an operating unit.
The second way the IT department could become a profit center is if the company determined that the department was one of the best in the industry, better in fact than some companies that existed just to provide IT services. The company could then allow the department the freedom to sell its services to outside customers. Thus, the department would still operate as a cost center in its dealings with other units inside the company, but it would operate as a profit center when it provided services to outside companies. This method of operation has become far more common in the 1990s and beyond, as companies seek new revenue streams that have low start-up costs.
If the IT department exists only as a cost center, it faces enormous pressure to provide services at the lowest possible costs. Because it does not generate profits, it must constantly fight to remain in existence and must fight off attempts to slash its budget to free up cash for the company's profit centers. Just as the company's senior management could decide that the IT department was good enough to operate as a profit center by soliciting outside clients, so too could it decide that the department is behind the times and is not providing adequate services. This would result in management choosing to shut down the department and contract with an outside vendor for the company's IT needs.
PROFIT CENTERS AND THEIR CHANGING ROLE IN INDUSTRY
In large companies, especially manufacturing companies, it has become a fairly common occurrence to break the company into small pieces, with each piece operating as a profit center that has to compete for business. In this manner, a large business can suddenly find itself operating as a small business. For example, say the Acme Company produces a finished product that is composed of five smaller parts. Instead of operating as one large company that produces all five parts needed for the finished product, Acme has decided to split into six separate units—one that assembles and sells the finished product, and five smaller companies that each produce one of the parts needed for the finished product. Beyond Acme, there are other companies that produce those same five parts needed to produce the finished product.
Each of the five part manufacturers is now operating as a separate profit center, reporting to Acme's corporate office. Each has to determine its own methods of operation, and each has to determine how it is going to show a profit. There may be internal agreements in place that mandate that each of the five units will continue to work together to produce the finished product, or Acme may throw things wide open by stating that there is no corporate mandate forcing the five divisions to continue to work together.
If the latter model is chosen, the corporation may have decided that, while the company could continue making steady—but small—profits if it kept using the five units together as it had for decades, there was a chance that the company could make huge profits if it made each of the five units accountable for its own bottom line and opened up the manufacturing process to both internal and external competition. In such a radical environment, it was conceivable that one of the five units could go bankrupt and cost the company money, but senior management believed that the hugely increased profits in the other four units, and the resulting higher profit margin realized by the sale of the finished product, would more than offset the loss of one unit.
Thus, each of Acme's five units, formerly divisions within the larger company that were not accountable for directly generating profits, were now separate entities that had to show a profit to continue operating. Each of the units had gone from a cost center mentality—buying materials to produce part of a product that showed up on the company's overall bottom line—to a profit center mentality, responsible for showing a profit based solely on the production and sale of its one part. As part of the shift to becoming a profit center, each of the five units would also be free to sell its part on the open marketplace. Acme might make that freedom a restricted one that prevented sales to a direct competitor, or it might take the full plunge and make the unit a fully stand-alone company that was free to sell its part to any other company in the market, including direct competitors. That decision would dictate whether Acme's move was a small one, designed to encourage each of its five units to think creatively and work harder to perform at a high level, or a large one, designed to change the very core of the company's business in a bid for higher profits.
PROFIT CENTERS AND SMALL BUSINESSES
When operating a small business, it may not be practical to use the profit center concept initially because the business is so small. Fewer employees mean fewer business units, which means fewer opportunities to create profit centers. In addition, in a small business, the president or the chief financial officer is probably monitoring financial results very closely, which means that he or she knows exactly where profits and losses are occurring. However, as a small business begins to grow, establishing profit centers often makes sense. Data Recognition, Inc. found that switching to profit centers made sense as the company increased in size. "Establishing profit centers, and generating daily profit/loss statements, has allowed us to better identify, and correct, our weaknesses," said vice president Steve Terry.
Even without adopting the profit center accounting concept, the idea of profit centers has value for small businesses in that they should always be looking for new ways to generate revenue. When operating a small business, there are essentially two ways to create a new profit center. The first method is to create an extension of the original business—a new product related to existing products, or new services that build on services that are already offered. The second method is to create an entirely new business altogether that can operate using the first business's corporate infrastructure (at least initially) and that can be operated at the same time as the original business.
The rapid spread of the World Wide Web has created an unprecedented method for creating new profit centers. Almost every company today has a Web site to dispense public relations information and to make it easier for customers to contact the company, but more and more firms are recognizing that there is money to be made on the Web. Most corporate Web sites begin life as a cost center, since they are initially just used to disseminate information, but most can be transformed into a profit center.
When seeking new profit centers, small business entrepreneurs should avoid business models that have regularly failed on the Web. These include setting up an entertainment site that attempts to charge a fee for that entertainment; relying on advertising as a revenue stream, as banner advertisements are proving to be quite unsuccessful in bringing in new customers; charging subscription or other visitor fees; and biting off more than you can handle by attempting to establish business-to-business sales that may not be achievable.
Materials Management-Profit Centre -----iimm

IntroductionIn the earlier years, Materials Management was treated as a Cost Centre, since Purchasing Department was spending money on materials while Stores was holding huge inventory of materials, blocking money and space. However, with the process of liberalization and opening up of global economy, there has been a drastic change in the business environment, resulting in manufacturing organizations exposed to intense competition in the market place. Indian manufacturers have been working out various strategies to face the above challenges and to cut down manufacturing costs to remain competitive. Progressive Management have since recognized that Materials Management can provide opportunities to reduce manufacturing costs and can be treated as a Profit Centre.
On an average, half the Sales income is spent on Materials. Suppose a firm is spending 50% of its volume on materials and the profits are 10% of sales volume. A 2% reduction in materials cost will boost the profits to 11% of sales or the profits will be increased by 10%. To achieve the same increase in profit through sales efforts, a 10% increase in sales volume will be necessary. In other words, compared to sales volume, material cost has five times the average on profits. Organizations earn or loose large sums depending on how effective are their Materials Management. The cost savings which are possible in Purchasing are as follows:a) By obtaining materials at lower prices through:
• Development of new sources
• Price negotiations with vendors
• Using modern techniques like cost-price analysis to determine the right or reasonable price for the materials
b) By managing taxes payable
c) By reducing the cost of packaging
d) By optimizing the transportation costs
e) By ensuring the right quality of materials
f) By value analysis
g) By import substitution
Profitability Till the last decade, the equation in business could be stated asSelling Price = Manufacturing Cost + Profit

In view of the current competitive pressures in the market, the equation has changed to: Selling Price - Manufacturing Cost = Profit

In the current situation, the Selling Price is determined by the market forces and as such, Profit can be ensured only by reducing the Manufacturing Cost. In most of the organizations, materials cost contribute to 60% of manufacturing cost and as such there is a significant importance to Materials Management. Materials Cost is divided into two segments:
a) Unit price of the Materials
b) Consumption for Production
The Purchase Department can control the prices by effective Negotiations. However, the question is, whether Materials Management can control the total cost, including the Consumption? Yes, it is possible, by controlling the issue from the Stores, based on the norms for Production. Now let us see how Materials Management can improve the PROFITABILITY of an organization –
Sales
100.0
100.0
200.0
Materials
70.0
63.0
126.0
Inventory
20.0
10.0
20.0
Interest @ 15%
3.0
1.5
3.0
Other expenses
17.0
17.0
30.0
Manf. Costs
90.0
81.5
159.0
PBT
10.0
18.0
41.0
% on Sales
10.0
18.5
20.5
% Increase

85.0
105.0
(All figures in Lakhs)
It may be seen from the above table, that just by reducing the material cost by 10%, the Profit has increased by 85%. Similarly, by reducing the materials cost and other expenses, for increased Sales, the profit has increased by 105%.



Inventory Management
The importance of proper management of Materials need hardly be emphasized. In any manufacturing industry, nearly 60% to 70% of the total funds employed are tied up in Current Assets, of which Inventory is the most significant component. In the cost structure of most of the products, materials constitute 50% of the total cost, again pointing to the need for the proper budgeting and control on cost of materials The objective of any commercial organization is to get the best mileage out of every rupee invested in the company. In other words, Management through their policies, decisions, coordination and control mechanisms must maximize the Return On Investment (ROI)
Profits ROI = ———————— Capital EmployedProfits = Sales - Manufacturing Cost
Manf. Cost = Labour (10%) + Materials (70%) + Overheads (20%)
Overheads include Bank Interest Charges of Inventory held.
Capital employed = Fixed Assets + Current Assets
Current Assets = Cash (10%)+ Receivables (20%) + Inventory (70%) From the above, it is clear that ROI can be maximized either by increasing Profit Margin or by reducing the Capital Employed or by both. In the current market situation, Sales Price cannot be increased (rather there is a demand to reduce it) and as such Profit can be increased only by reducing the Material Costs.On the other hand, the opportunity to reduce the Overheads and Capital Employed is more by Inventory Reduction. It is thus evident that the ROI can be maximized by either reducing the material cost or reducing the current assets by way of inventory of materials or can be optimized by increasing profits and reducing capital employed.It is evident that the Materials Manager can make a direct contribution in increasing Profitability in the following ways:
By deciding inventory norms rationally and through control systems. Inventory Turnover can be maximized which in turn will maximize current Assets Turnover and ROI
By proper planning and control of Spare parts, capacity utilization can be increased which will increase the turnover of Fixed Assets and consequently increase ROI
By developing dependable sources and purchasing quality materials at competitive prices, materials cost per rupee of sales can be brought down which will increase Profit Margin and in turn ROI
By developing proper systems and control on issue of materials, the consumption can be minimized, resulting in reducing the materials cost, which will increase the Profit Margin and also ROI Let us now see the financial position of three companies – A, B, C, and how the ROI has improved by controlling the Inventory (all figures in lakhs)
Items
A
B
C
Assets
5.00
5.00
5.00
Inventory
8.00
6.00
4.00
Cash/Credit
1.00
1.00
1.00
Borrowing
3.00
2.00
1.00
Sales
20.00
20.00
20.00
Operation Costs
18.00
17.50
17.00
Interest @ 15%
0.45
0.30
0.15
PBT
1.55
2.20
2.85
ROI %
11.00
18.30
28.50
Realizing the effect of materials on the functioning of any organization, all areas connected with receiving, buying, stocking, issue of materials, are being brought under the name of “Materials Management” as one function in the organization. We can define Materials Management as “the function responsible for the coordination of planning, sourcing, purchasing, moving, storing and controlling materials in an optimum manner so as to provide a predetermined service to the customer at a minimum cost.” Material Planning and Inventory Control is the most important function of Materials Management and it forms the nerve centre in any organization.

A segment of a business for which costs, revenues, and profits are separately calculated.
Profit Center
The branch or division of a company that creates profits individually and separately from the main organization.
Investopedia Says: The profit center's revenues and expenses are held separate from the main company's in order to determine their profitability.
Accounting Dictionary: Profit Center
Responsibility unit that measures the performance of a division, product line, geographic area, or other measurable unit. Divisional profit figures are best obtained by subtracting from revenue only the costs the division manager can control (direct division costs) and eliminating allocated costs common to all divisions (e.g., an allocated share of company image advertising that benefits all divisions but is not controlled by division managers). Profit is a very often used method to evaluate a division's financial success as well as the performance of its manager. In determining divisional profit, a Transfer Price may have to be derived. The divisional profit center allows for decentralization. As each division is treated as a separate business entity with responsibility for making its own profit. See also Responsibility Accounting; Responsibility Center.
Small Business Encyclopedia: Profit Center
A profit center is a unit of a company that generates revenue in excess of its expenses. It is expected that, through the sale of goods or services, the unit will turn a profit. This is in contrast to a cost center, which is a unit inside a company that generates expenses with no responsibility for creating revenue. The only expectation a cost center has is to lower expenses whenever possible while staying with a specific budget that is determined at the corporate level.
Beyond that simple definition, the term "profit center" has also come to represent a form of management accounting that is organized around the profit center concept. Companies that have adopted the profit center system have organized all of their business units as either profit centers or cost centers, and all company financial results are reported in that manner. Adopting a profit center system often requires a radical shift in corporate philosophy and culture, but it can yield great returns in net before tax (NBT) profits. According to an article in Business Solutions, the data collection company Data Recognition, Inc. made the shift to a profit center-based system and was pleased with the results. "We saw the importance of evaluating, individually, areas of our business that are distinctly different," said Steve Terry, the company's vice president of systems. "The profit centers have allowed us to better identify specific gains and losses. And that's critically important for a growing business."
All companies, no matter what size, have both cost and profit centers (although, if it is a single-person company, that company would really have profit and cost activities, since all business "units" are the same person). For example, in most companies, units such as human resources and purchasing are strictly cost centers. The company has to spend money to operate those units, and neither has any means of producing a profit to offset those expenses. They exist solely to make it possible for other areas of the company to make money. However, without those two departments, the company could not survive. Examples of profit centers would be the manufacturing units that produce products for sale to consumers or other businesses. The sale of those products generates a profit that offsets the expense of creating the products.
All companies have profit centers and cost centers, but not all companies organize their accounting practices around the profit center concept. In fact, most companies do things the time-honored way, producing overall profit and loss statements for the company as a whole, without making each business unit accountable for generating a profit.
Profit Centers are parts of a Corporation that directly add to its Profit.
Managers are held accountable for both revenues, and costs (expenses), and therefore, profits.
Usually the different profit centers are separated for Accounting purposes so that the management can follow how much profit each makes and compare their relative efficiency and profit. Examples of typical profit centers are a store, a sales organisation and a consulting organization. Profit centers can measure profitability of business units or departments.