Difference Between Cost Centre And Profit Centre

A cost centre is a centre where costs are determined and later utilized to regulate the expenses. Profit Centre, on the other hand, is a centre whose effectiveness we can gauge by its ability to generate revenue.

Businesses usually divide the organization into a number of smaller components, and then use the cost information as efficiently as possible. These subunits represent the smallest section of activity or area of duty. They are merely expense centres.

Cost centres are the parts of the company where expenses are incurred and documented, either by the item, by the product, or by the department. The profit centre, on the other hand, is the division of the company where expenses and revenues are incurred and recorded according to a product or product line.

These two are important components of the organization. They give managers valuable information to help them make right decisions. The group also facilitates benchmarking, problem identification, and accountability improvement.

Despite having different functions and goals, profit and cost centres are essential for the success of a corporation.

Cost Centre Meaning

A cost centre is a division or department that manages, distributes, isolates and eliminates all kinds of business expenses. The cost centre's main responsibilities are to monitor an organization's expenses and restrict any unneeded spending that the business may incur.

Both the number of participants and the location can determine the cost. The cost centre in multinational corporations has the authority to control and lower costs. Usually, to keep an eye on these expenses, the actual cost incurred is analyzed and subtracted from the standard cost.

A cost centre is an organization's department or division that focuses on its own expenses. Its role is to regulate and minimize excessive expenses that a business can face.

For example, a customer service centre helps an organization reduce costs that may result from unresolved customer complaints and grievances, even though it does not directly provide income or profit.

In this sense, it is important to remember that while the cost centre itself has expenses, it helps the profit centre produce more income and profit.

It can be assessed by contrasting intended expenses with conventional costs. Knowing how or to what extent goals are met will be helpful.

A distinction exists between a cost centre and a cost unit.

Cost Unit is required to measure cost in terms of service or product units. Whereas, the cost centre, is a division inside an organization.

Why Are Cost Centres Important for Organizations?

Many startups may contend that cost centres should not be kept inside the company because they don't directly produce revenue and come with a lot of expenses.

The idea is that cost centres assist profit centres in directing the operations of the business.

Let us assume that the organization does not have a cost centre. This implies that the company will not conduct research and development, innovate on its current offerings, or create new goods.

For instance, if a customer service division won't exist. It will mean that no consumer would receive good service if they encountered any difficulties.

The company won't have a branding or marketing department, so it will continue to make items, but no one will be aware of them or the business.

Maintaining cost centres is critical to the organization's long-term viability and survival. Yes, if necessary, they can occasionally be delegated to the appropriate partner. However, the profit centres need support from the cost centres to function effectively. And as a result, there will be little profit generation eventually.

How Can the Effectiveness of a Certain Cost Centre Be Measured?

It's been said that you can't get better if you can't quantify it. For this reason, we must devise a system for gauging a cost centre's effectiveness.

We must execute a variance analysis in order to determine the difference between the standard cost and the actual cost and to assess the performance of a cost centre.

Standard costs are being set according to the target to measure how well the mark is being fulfilled. Actual costs are the costs that are incurred in reality.

Variance analysis can be done in two ways - first through price variance and then through quantity variance.

Types of Cost Centre

1. Personal Cost Centre

This type of activity centre comprises persons or groups of persons in connection with which costs are ascertained. For example, a sales manager works as a manager, and so forth. To gauge how well the mark is being met, standard charges are defined based on the target. The expenses that are actually incurred are known as actual costs.

There are two methods for doing variance analysis: quantity variance and price variance.

2. Individual Cost Centre

This kind of activity centre consists of individuals or groups that are related to the expenses that are determined. Sales managers, work managers, and so on are a few examples.

3. Impersonalized Cost Centre

An impersonal cost centre consists of a department, location, or piece of equipment, such as a machine shop, warehouse, sales region, and so forth.

Additional Classification

1. Centre for Production Costs

Manufacturing cost centres are the locations where the company carries out its conversion or manufacturing operations. Here, raw materials are transformed into goods that are prepared for retail. For instance, machine shops, bakeries, milling shops, etc.

2. Centre for Service Costs

These centres support the production cost centre by serving as auxiliary units. The canteen, Maintenance Shop, Toolroom, Accounts, Power House, etc., are a few examples.

Different Kinds of Operational Cost Centre

It stands for those devices or people who do the same tasks. The goal is to calculate the cost of every operation, independent of where it occurs in the unit.

1. Centre for Process Costing

It stands for the cost centres that carry out a certain procedure or set of tasks. For instance, steel mills, oil refineries, etc.

2. Division of the Cost Centre

• Based On Department: Here, every department functions as a distinct cost centre. For instance, purchasing, production, marketing, finance, human resources, and research & development.
• Based On Product: A company that produces a variety of goods may designate a certain cost centre for each product. LG, for instance, produces televisions, cell phones, washing machines, microwaves, refrigerators, and so forth. Due to production costs incurred by the company, each of these products may serve as a cost centre.
• Geographically: Multinational corporations (MNCs) such as Pepsico and Apple have locations across the globe. Every one of these locations where the company operates is a cost centre.
• Based On Employee: Certain businesses have expenses associated with individual employees. These people are, therefore, cost centres. Managers and salespeople, for instance, are cost centres.

Profit Centre Meaning

A profit centre is a department or section of a business that functions to determine profit. Managers oversee various profit centres, determining profits based on expenses and income. The profit centre is responsible for all activities related to production and product sales.

The primary goal of a profit centre is to increase sales and minimize costs in order to produce and maximize profit. This goal contributes to increasing a company's capacity to turn a profit.

Profit growth during a specific time period measures a profit centre's accomplishment. A profit centre's performance is measured by deducting its actual costs from its planned costs.

What is the Profit Centre?

The division of a business that generates revenue and profit while also accounting for related expenses is known as the profit centre.

For example, a company's ability to generate profits is closely linked to its sales department. It also establishes estimates for revenue.

Cost centres support profit centres, which don't function in isolation.

The effectiveness of a profit centre can be measured in various ways. One widely used approach is to compare budget and profit.

The Importance of a Profit Centre

The importance of a profit centre can be attributed to the fact that it serves as the principal source of profit generation for an organization or business. It is also useful for calculating investment returns.

In addition to generating income and profits, the actions taken by profit centers facilitate effective decision-making. The activities that are most likely to result in increased expenses are eliminated. Another factor in budgetary control is a profit centre.

Profit Centre Types

1. Department Within the Organization

These profit centres are found in departments inside a company. For instance, a company might have a sales department. It is the main profit centre in any organization.

2. The Strategic Unit of An Extremely Large Organization

External to a multinational company or bigger corporate body are strategic sub-units. A restaurant in a large hotel chain, for instance, functions as a strategic unit profit centre.

Functions Of Profit Centre

Profit centres only do a little specialized work. They are as follows:

• Make Immediate Financial Gains: Profit centres help their operations to make direct profits. For example, the sales department makes money by selling products to customers directly.
• Calculate Investment Returns: Since profit centres are also in charge of revenues and expenses, it is easy to compute returns on investments made there.
• Assist In Reaching Informed Decisions: Because profit centres generate revenue and profits immediately, making informed decisions is made easier. Reduce the amount of work that adds to expenses but doesn't generate profit and focus more on the projects that generate the most revenue.
• Aid In Budgetary Control: Profit centres provide additional budgetary control because their evaluation is predicated on subtracting actual costs from budgeted expenditures.
• The profit centres are able to comprehend the discrepancy and use the lessons learned in the subsequent set of requirements when they compare the actual costs with the budgeted expenses.
• Gives extrinsic incentive: The profit centre team has direct influence over revenues and earnings; therefore, they receive rewards for their efforts, which provides them with an external incentive to increase productivity and profitability.

How Can One Assess a Certain Profit Centre's Performance?

The profit centre's performance can be evaluated in five different ways. Let's examine each one of them:

1. Budget To Profit Comparison: Each profit centre establishes a budget for expenses and income. We may immediately assess the accuracy of our assumptions by comparing them to the real cost and income.
2. Profit Margin Per Unit: It is simpler to look at the company's profits and divide them by the number of units sold as profit centre managers. We can, therefore, calculate the profit per unit.
3. Gross Profit Percentage: This can be calculated by dividing the total profit by the number of sales.
4. Net Profit Percentage: This can be calculated by dividing the net profit by the total number of sales.
5. The Ratio Between Expenses and Sales: Since a profit centre can see the actual expenses and the actual sales, it's easy to find a ratio between them.

Benefits of the Profit Centre

Key benefits of Profit Centre are;

• Wide-ranging assessment
• Top management's release from daily decision-making
• An improvement in the standard of judgment

The Drawbacks of The Profit Centre

• Subunits can compete with one another, which can prevent them from working together.
• An increase in conflict between different departments. There may also be disagreements on the transfer price that one profit centre will charge another.

Conclusion

Overall, we now know that the two are quite similar, but the distinction is that the profit center tracks revenues in addition to keeping a record of each center's expenses, while cost centers merely keep track of expenses.