What are profit centers responsible for?

A profit center is a part of a business which is expected to make an identifiable contribution to the organization's profits.

Overview[edit]

A profit center is a section of a company treated as a separate business. Thus profits or losses for a profit center are calculated separately.

A profit center manager is held accountable for both revenue and costs (expenses), and therefore for profits. This means that the manager is accountable for driving the sales revenue generating activities which lead to cash inflows and at the same time controlling the cost-generating activities. This makes the profit center management more challenging than cost center management. Profit center management is equivalent to running an independent business because a profit center business unit or department is treated as a distinct entity enabling revenues and expenses to be determined and its profitability to be measured.

Business organizations may be organized in terms of profit centers where the profit center's revenues and expenses are held separate from the main company's in order to determine their profitability. Usually different profit centers are separated for accounting purposes so that the management can follow how much profit each center makes and compare their relative efficiency and profit. Examples of typical profit centers are a store, a sales organization and a consulting organization whose profitability can be measured.

Peter Drucker originally coined the term profit center around 1945. He later recanted, calling it "One of the biggest mistakes I have made". He later asserted that there are only cost centers within a business, and “the only profit center is a customer whose cheque hasn’t bounced”.[1]

1. Consumer: Broad range of products used in the following markets: baby care (e.g., Johnson’s), oral care (e.g., Listerine), beauty. (e.g. Neutrogena), over-the-counter pharmaceutical (e.g., Tylenol), women’s health (e.g., Carefree), wound care (e.g., Band-Aid).

A profit center is a business unit or department within an organization that generates revenues and profits or losses. Management closely monitors the results of profit centers, since these entities are the key drivers of the total results of the parent entity. Management typically uses profit center results to decide whether to allocate additional funding to them, and also whether to shut down low-performing units. The manager of a profit center usually has the authority to make decisions regarding how to earn revenue and which expenses to incur.

Profit centers may be included in the segment reporting of a publicly-held entity. Privately-held businesses do not have to report this information as part of their financial statements.

Profit Centers vs. Cost Centers and Investment Centers

Other types of reporting entities within a business are the cost center and investment center. A cost center is only responsible for its costs, while an investment center is responsible for its return on assets. In terms of responsibility level, the profit center lies between the cost center and responsibility center.

A profit center is the division or department of a firm that promptly contributes or is presumed to contribute to the company’s net profit. The profit center manager supervises the department accountable for income generation and earnings. Furthermore, the sales division is one of the usual examples.

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Please note that there might be numerous profit centers in an organization with an appointed manager for each one. Moreover, the primary difference in terms of profit center vs cost centerProfit Center Vs Cost CenterThe cost center is responsible for identifying and maintaining the organization's cost as low as possible by analyzing the processes and making necessary changes. In contrast, a profit center focuses on generating and maximizing revenue streams by identifying and improving activities.read more lies in their definition. While the former handle profits, the latter supervises the company costs.

Table of contents

• What is a Profit Center?
  • Profit Center Explained
  • Examples
    • Example#1
    • Example#2
  • Profit Center Advantages
  • Frequently Asked Questions (FAQs)
  • Recommended Articles

Key Takeaways

• A profit center is a freestanding business sector or unit in the company responsible for producing gains and returns.
• There may be single or multiple profit centers in a company with a designated profit center manager for each one of them.
• It is among the three types of responsibility centers besides cost (handles incurred costs) and investment (supervises earnings on assets) centers.
• Its benefits incorporate reduced overhead costs, control of expenditure, the ability to take more risks, and cost distribution.

Profit Center Explained

A profit center, is a category of responsibility centersResponsibility CentersThe term "Responsibility Center" refers to a specific segment or unit of an organization for which a specific manager, employee, or department is held accountable and responsible for its business goals and objectives.read more that is crucial to discover the most and the least beneficial segments in a corporation. Moreover, it is among the three principal organizational units in each establishment, apart from the cost centerCost CenterCost center refers to the company's departments that don't contribute directly to the corporate revenue; however, the firm has to incur expenses for keeping such units operative. It comprises research and development, accounting and human resource departments.read more (for pricing) and investment centerInvestment CenterAn investment center refers to an organizational unit where the manager is responsible for expenses, revenue, and investments. The parent company has delegated adequate authority to the manager or the head of the unit to decide, implement and manage the unit’s operation.read more (for yield on assets).

The cost center includes accounting departmentsAccounting DepartmentsThe accounting department looks after preparing financial statements, maintaining a general ledger, paying bills, preparing customer bills, payroll, and more. In other words, they are responsible for managing the overall economic front of the business.read more, while the profit and investment centers represent the sales division and financing arm, respectively. Please note that the profit center definition implicates the formation of a unit to coordinate the enterprise sectors with their accountingAccountingAccounting is the process of processing and recording financial information on behalf of a business, and it serves as the foundation for all subsequent financial statements.read more data.

Regarded as an individual unit or a separate business, the company independently computes its gains and losses. It certainly confirms that the gross proceeds (detailed in ledgersLedgersLedger in accounting records and processes a firm’s financial data, taken from journal entries. This becomes an important financial record for future reference. It is used for creating financial statements. It is also known as the second book of entry.read more) can finance the requisite business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more.

Its smart usage for budgetingBudgetingBudgeting is a method used by businesses to make precise projections of revenues and expenditure for a future specific period of time while taking into account various internal and external factors prevailing at that time.read more and assessment aids you in taking risks, organizing disbursements, and discerning profitable goods and services. Furthermore, the public corporations can incorporate this center under segment reportingSegment ReportingSegment Reporting is the disclosure of financial details of key units or segments by public companies and is based on certain regulatory requirements. read more while private companiesPrivate CompaniesA privately held company refers to the separate legal entity registered with SEC having a limited number of outstanding share capital and shareowners. read more are not required to include it in their account statements.

The individualistic examination of all profit centers allows precision and insightful comparison between branches. Moreover, their manager decides tasks to be eliminated and improved and guarantees appropriate resource and capital assets distribution.

They also control business expenses and ascertain the product costing. The managers may certainly expand the bandwidth for specific activities or change the mode of operation. However, on a general basis, they are accountable for raising the sales and earnings of the center.

For example, the profitProfitProfit refers to the earnings that an individual or business takes home after all the costs are paid. In economics, the term is associated with monetary gains. read more, or revenue-generating, centers of a financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more are accounting services, consulting services, and investment bankingInvestment BankingInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more. It encompasses earnings received from customers and spending by hiring workers on payrollPayrollPayroll refers to the overall compensation payable by any organization to its employees on a certain date for a specific period of services they have provided in the entity. This total net pay comprises salary, wages, bonus, commission, deduction, perquisites, and other benefits.read more and hardware used to offer these services.

Examples

For better understanding, here are the profit center examples.

Example#1

Suppose that a grocery chain possesses three profit centers: vegetable oil, packaged beverages, and the body shop division. According to the accounting reportsAccounting ReportsAccounting reports are created using a company's accounting data to check ledger-by-ledger transactions over a given time period. Accounting reports also include financial statements such as cash flow statements, profit and loss statements, and balance sheets.read more, the return on these sectors is $15000, $18000, and $25000, respectively.

The direct costDirect CostDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more is $8500 (vegetable oil), $10700 (packaged beverages), and $14200 (body shop). While the entire indirect costIndirect CostIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more is $1500, divided equivalently due to the unavailability of another framework.

Now, let’s determine the product-specific income received.

Consequently, the body shop section acquires the maximum revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more while the vegetable oil division procures the lowest income.

Example#2

Learning and development sectors are crucial to the success of an enterprise and, thus, its biggest profit centers. For example, after the onset of Coronavirus, it is reported that 70% of the employees will be somehow working remotely by 2025. Also, firms would save $11000 annually per worker due to remote work.

99% of the remote workforce would like to continue it (at least part-time) for the rest of their professional life. However, since remote working may develop a feeling of detachment, investment in learning and development programs is critical.

Throughout the last few years, the client of The Game Agency, namely IT Cosmetics, has swiftly broadened. After producing an interactive training session, the firm’s vice president of education successfully attracted the latest and expert retail sales partners globally.

Profit Center Advantages

To clarify, let’s go through its benefits.

Reduction Of Overhead Costs

It helps other business divisions reduce overhead pricing and charges to maintain the limited gains. Consequently, they may attempt to restrict their expenditures, ultimately bringing in more revenue.

Regulation Of Expenditure

Owing to this center, an organization is well-informed about how and where the prices are incurred. This aids in budgeting and forecasting activities to determine the appropriate fund allocation method. The company can easily meet its target, and employees will receive the incentives.

Permitting Risks

As the company dedicates a whole division to profit generation, it may take additional risks. For instance, the enterprise can transfer some funds into launching a new service or product. This certainly helps in the expansion of the firm.

Pricing Segmentation

Each business segment possesses its financial records individually. Needlessly, this benefits both the individual division and the company. As a result, the individual branch can focus more on its strengths and bridge the monetary loopholes. Also, the organization can assess each segment individually for increased productivity.

Frequently Asked Questions (FAQs)

What Is a Profit Center in Accounting?

In accounting, a profit center is the branch or division of an enterprise that supposedly adds to its bottom line, for example, the sales department of a firm. It is considered an independent business unit or sector, and therefore, the firm separately calculates its net profit and losses.

What Is an Example of a Profit Center?

The most common example of a profit center is the independent retail stores in a huge retail chain (like Walmart). However, it may also include the individual restaurants of a multinational restaurant chain or manufacturing sectors in big corporations.

What Is a Profit Center Vs Cost Center?

The profit center definition infers the business sector that contributes to its net profit. On the other hand, the cost center denotes a business sector that oversees all the business-associated pricing. Both terms differ regarding profit center vs cost center in their responsibilities, involved methodologies, and operational scope.

Recommended Articles

This has been a guide to Profit Center and its Definition. Here we explain the profit center’s advantages, examples, and duties of its manager. You can learn more from the following articles –

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What is a profit center and how is its performance evaluated?

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