Profit Center
Profit Center is a section of a company that is treated as a separate sub-business within a company to which revenues can be traced. It directly adds to the profits of the company, hence it is responsible for its own costs and revenues.
Each profit centre or a few are managed by profit centre managers who are responsible for their own centers. This helps organizations to compare different profit centers and determine which ones need more attention and are earning fewer profits, etc.
Profit centers may be divisions, subsidiaries or departments. Results of profit centers are generally included in externally reported segment results.
Example
Asset management department (for an asset management company), Sales department, Advice & Wealth Management (for a wealth management company) etc.
Total of AWM will be total of all it sub profit centers
Profit Center and Cost Center
A profit center is that part of the activity of a business that is considered responsible for earning revenue and incurring expenses and also establishes the profit of a particular segment of activity. Profit centers are maintained to measure the performance of each individual to whom the responsibility was delegated.
A cost center is the smallest unit in an operational organization for which distinct cost collection and analysis is attempted. A cost center can be defined as an observable unit in a big organization, that is established for the convenience of cost detection.
Difference in Table Format
Why is the Profit Center important?
Managerial accounting mainly focuses on identifying the sources of profits in a business. This leads to accumulating the revenue generated and the expenses incurred in respect of these sources of profit.
- Most organizations depend on the traditional income statement that shows the overall profit and cost for the whole business. The real problems and opportunities can be explored only with granular information.
- Profit centers can help a business earn a superior return on its investments given the utilization of its limited resources in comparison with alternative opportunities available to it, with help of profit comparison.
- Many businesses try to capture new markets by pricing their products and services too low. Price is very crucial in the absence of value. Charging prices below the required profit renders the business unsustainable. Hence, a grasp on expected profit levels is very much required.
- Profit centers promote healthy competition among different units of the same business. The aim is to allow a microscopic view of the observable units of the business to establish how each of these units is performing financially, in terms of profitability.
- Profit centers increase the profit consciousness of the business leading to overall enhanced profitability of the organization.
Problems with Profit Centers
There are reasons for a business to establish profit centers but, the process may lead to some difficulties also:
- Profit Centers can lead to decentralization. But, decentralized decision making may force the top management to rely further upon the mid-management reports. This leads to a loss of control.
- Divisionalization can lead to additional costs because of the additional required management controls, staff, and record-keeping resources.
- An excess of Profit consciousness may result in overemphasis on short-run profitability at the expense of long-run sustainable growth.
- There is no completely functional system in place yet, to ensure that divisional profit will contribute to the overall organizational growth or not.
- There has to be a check on the level and nature of competition budding among different profit centers of the same business.
Short Quiz for Self-Evaluation
> ReadCost Centerand Service Center