Cost Centres and Profit Centres

Content Cost Centres Profit Centres How to create them Uses of cost / profit centres Advantages Disadvantages Examples

Definitions 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

Cost and Profit Centres 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

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

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

Uses Of Cost / Profit Centres 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.

Why operate 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 / 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