Cost Centres & Profit Centres

Cost centre – An identifiable part of an organisation where costs can be calculated

Profit centre – An identifiable part of an organisation where costs and revenue can be calculated

• You need to be able to allocate all costs to a certain area
• If you can calculate revenues as well as costs can calculate profit (Total revenues- total costs)
• These are often used with budgets to assist with financial planning and control

Uses of Cost and Profit centres

• They allow the business to compare performance between departments / across products / brands etc
• This allows the business to make decisions about underperforming areas
• If a profit centre is identified as doing well businesses may want to focus on the reasons behind this
• They allow a more focused study of a firms finances
• Benchmarking can take place
• Responsibility for a profit / cost centre will motivate the individual responsible
• By placing responsibility with the person involved in the activity the finances may be run more efficiently than would be the case if a more remote, senior manager controlled it.

Creating Cost and Profit centres

Cost / profit centres can be created in a number of ways:

• Geographically e.g high street banks
• Product / line of production
• Departments / divisions
• Individual products / brands

Advantages of Cost and Profit centres

• Financial reasons – they allow you to manage and control money. They allow the business to identify which areas are most profitable
• Organisational reasons – helps with the organisation of departments and resources
• Motivational reasons – motivates managers and workers

Disadvantages of Cost and Profit centres

• In practice, it may be difficult to allocate costs to a particular division / centre
• Cost and profit centres may add to pressures and stress on staff
• Senior managers may be unable to recognise whether a cost or profit centre is running effectively / ineffectively

Summary

• Cost Centres:  calculate costs attributed to a specific area of the business
• Profit Centres: calculate costs and revenues attributed to a specific area of the business
• Ways to generate them: by geographical area, product, brand ,department
• Uses of cost / profit centres: they have financial, motivational and organisational uses
• Advantages: helps control money, motivates staff
• Disadvantages: can be difficult to do, may increase pressure