The profit centre is a separate department or division of an enterprise which calculates profits earned by the enterprise. In a company, different profit centres are managed by managers responsible for the profit earned. They depend on revenues and costs and must monitor both to ensure profit is earned as desired. The entity's management, for effective internal control of the organisation, can use profit centres.
Did You Know? Profit-center marketing occurs when the marketing function generates measurable revenue for a company.
What Is A Profit Centre?
Profit centres are crucial to every organization as they help to determine which units of the company are profitable and which are not. This helps to provide proper analysis and differentiate between the entity's revenue streams. This analysis can be used when allocating funds and resources among the various revenue-generating departments.
Managers shall be assigned to each profit centre who can determine prices and operating costs related to his profit centre. They also face pressure from management as they shall be directly responsible for their division's revenues, costs, and profits.
As seen above, a profit centre is a branch or division of the company which directly adds to the company's profitability. It is treated as a separate business having its revenues and costs accounted for on a standalone basis. This means that profit centres are the self-contained entity within the entity that practically operates independently, producing their costs, revenues and profits.
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Characteristics of a Profit Centre
The following are some of the characteristics of a Profit Centre:
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Independent Unit
It operates on a standalone basis within the company. It is considered a company within the company. Each business unit with a revenue stream shall be considered a separate profit centre for internal control purposes.
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Revenue Driver
The profit centre is responsible for revenue generation for the organization by driving sales and bringing in cash flows. The profit centre manager is held responsible for maximizing revenue as per the targets set by the entity's management.
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Net Income Maximisation
The goal of a profit centre is to maximise revenue and sales for the organization. The profit centre is not only responsible for revenue but also costs.
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Responsible for Revenues and Costs
The managers of profit centres have been given decision-making powers over revenues and costs related to their business unit. They are given the authority to take steps necessary to boost revenues and eliminate unwanted expenditures to generate profits for the entity.
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Accountable For Profits
The profit centre managers shall be accountable for generating profits for their business units, thereby meeting the profit standards of the entity. They shall have full authority and responsibility to make decisions and take actions that shall drive revenues and improve profitability for their respective business centres.
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Performance Management
Financial ratios and metrics are calculated for each profit centre to measure its performance against set targets and the performance of other centres. The bonuses and perquisites of managers of profit centres shall be directly linked to the profitability of their business centres.
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Advantages of a Profit Centre
The following are the advantages of profit centres :
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Reduction of Overhead costs
It helps reduce overhead pricing and ensures minimum gains are achieved. They also restrict expenditures, thereby bringing in more revenue to the entity.
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Regulating Expenses
By using profit centre accounting, the organization is aware of each business centre's expenditures. It enables the entity to perform budgeting and forecasting more efficiently and ensure appropriate fund allocation among business centres.
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Permits Risks
Company that dedicates an entire division to profit generation leads to additional risks. For instance, the enterprise can transfer funds to launch a new service or product. This helps in the expansion of the organization.
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Pricing Segmentation
Financial records and accounts are maintained separately for each profit center. This is beneficial to both the profit centres and the entity. Each business centre can focus on its strengths and identify and cover up its loopholes. Assessment of each business centre allows for increased productivity of the organization.
Profit Centre Accounting
Profit Centre Accounting helps to determine the profits and losses for each profit centre for the given period. It can be done using the cost-of-sales approach or period accounting method. This type of accounting helps to analyze revenues and lets you explore fixed capital and other statistical figures, such as the number of employees.
A profit centre is created for internal control purposes, unlike business areas designed for the better external presentation of financial data. Dividing the entity into profit centres helps to analyze areas of responsibility and delegate responsibility to these decentralized units for effective entity management.
Profit centre accounting is a strategic tool that shall enable the management to take important decisions. Most other organizations rely on the overall profit and loss statement to make decisions. But this can prove to be tedious and, at times, misleading. It does not provide insight into the profitability of individual lines of business, internal departments, branch offices, or even individual producers of the company. Further, profit centres also stimulate healthy competition between each unit and its managers.
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Difference Between Cost Centre And Profit Centre
As a profit centre, a cost centre is also a department or unit that supervises, allocates, segregates, and eliminates all sorts of costs related to a company. Cost centres enable the limiting of unwanted expenditures and help to keep a check on costs incurred by the company. A few types of cost centres commonly seen in organizations are the Production cost centre, Personal cost centre, Service cost centre, Impersonal cost centre, Process cost centre, and Operation cost centre.
The following are the differences between Cost Centre and Profit Centre –
|
Basis |
Cost Centre |
Profit Centre |
|
Definition |
This is a company’s department that supervises all the costs of the company |
This is a company’s department that is responsible for profits earned by the company |
|
Responsibility |
Effective cost control and reducing costs of the entity |
Maximizing revenue thereby increasing the profits earned by the company |
|
Complexity |
The cost centre has lesser complexity as compared to the profit centre because they only must focus on cost optimization. |
The profit center’s functions are more complex because it has to improve the profits of the entity for which focus is required on costs, revenues, and profits. |
|
Approach used |
Short-term approach |
Both short-term and long-term approach is followed |
|
Scope of Operations |
Comparatively, the scope of the cost centre is narrow |
Wider scope as compared to cost centre |
Examples of Profit Centre
Profit Centres is treated as a separate, standalone business, responsible for generating its revenues and earnings.
Here are a few examples of profit centres :
- Individual restaurants in a large chain of restaurants
- Manufacturing divisions in a large corporation
- Individual retail stores in a large chain of retail stores
- Subunits are deliberately established in organizations to maximize profits of these subunits.
- A grocery chain has separate profit centres based on products such as vegetable oil, packaged beverages, and the body shop division.
- Learning and development sectors shall also be considered as profit centres of the entity.
Conclusion
The organisation should always remember the activities carried out by the business centre before classifying it as a profit centre. Business organisations can use profit centres effectively to measure the performance of various business centres. It can be used for budgeting and forecasting as well by the management. Cost centres can be merged with profit centres to ensure that there are no unwanted expenditures and there is cost optimisation.
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