Once we know about the most important equation in business, the other two crucial concepts related to costs management need to be understood – Cost Centers and Profit Centers.
When a business grows, it becomes more and more difficult to manage, especially its finance. All business costs and revenues from many different areas of business operations are becoming harder to account for due to growing complexity and interdependence.
Therefore, in order to make managing the whole business and its finance easier for business managers, various sections of the business will be divided up either into Costs Centers or into Profit Centers. Each center will have its own person in charge who will be held responsible for its financial performance.
Cost Centers
The Cost Center is a product, unit, section, department or branch of the business to which costs can be allocated. Cost Centers incur costs only and are not involved in making any profit.
Why having Cost Centers?
Cost Centers allows a business organization to identify which costs are clearly attributed to the activities of each product, unit, section, department or branch. It will help managers to have better control over costs as they are able to clearly see how each Cost Center contributes towards the firm’s overall total costs. For example, which Cost Center generates the highest costs. Different Cost Centers will also be held accountable for their performance.
Examples of Cost Centres
In manufacturing businesses, it will be products, processes, departments or even whole factories involved in the production process.
At schools it will be different sections which have different needs such as a kindergarten, primary school, middle school and high school.
In hotels, it will be the reception hall, rooms, kitchen, restaurant, bar, conference hall, swimming pool, etc.
Profit Centers
The Profit Center is a product, unit, section, department or branch of the business to which both costs and revenues can be allocated. Then, the profit will be calculated. Profit Centers incur both costs and revenues, and are involved in making profit for the business.
Why having Profit Centers?
Having Profit Centres allows a business organization to identify the areas in a business organization that generate the most, or the least sales revenue and profit. Each Profit Center is responsible for contributing to the overall profits of the business. Based on this data, business managers can hold each Profit Center accountable for better costs control, hence maximizing profits for the business.
Examples of Profit Centres
Profit Centers tend to be used by large multinational businesses that have diversified Product Portfolio.
Each product in the overall portfolio of the multi-product business such as Procter & Gamble will run different Profit Centers for different types of products such as shampoos, deodorants, shower gels, laundry detergents, etc.
In a daily newspaper such as Wall Street Journal that sells advertising space, Profit Centers will be different sections such as front page, second page, the center spread, full page inside the newspaper or back cover.
In a restaurant, it will be different types of foods from the menu such as starters, main course, desserts, alcoholic drinks and non-alcoholic drinks.
Each department in a bank will be Profit Center based on the source of revenue such as personal banking, commercial banking, private banking, credit cards, foreign exchange, loans, mortgages, insurance, etc.
Each branch of a chain of restaurants in a franchising business will be a Profit Center based on geographical locations for companies such as Starbucks, Costa Coffee, McDonalds, Dairy Queen, KFC, Burger King, etc.
In summary, a Finance manager will be assigned to monitor and manage two things in relation to Costs Centers and Profit Centers. First, all spending of each Cost Center to see which centers are costing the firm the most money. And, secondly, by producing an independent Profit and Loss Account (P&L) for each Profit Center, the manager will present financial information regarding both sales revenue, costs and profits.
