Profit Centre: Definition, Importance, and Examples
By Indeed Editorial Team
Published May 14, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Profit centres are divisions of a company that can add to the company's overall business profits. Profit centres are responsible for generating revenues and earnings, and companies calculate their profits and losses separately from other areas of the business, allowing accountants to treat them as separate, stand-alone entities. Understanding how profit centres work can help you manage company profits to boost overall productivity and efficiency. In this article, we explain what profit centres are, discuss the differences between profit centres and cost centres, highlight why they're significant, show you how they work, and provide some examples.
What is a profit centre?
A profit centre is a branch of an organization that leaders design to create additional revenue. Creating one of these centres may help an organization identify its most and least profitable products. Creating a profit centre can facilitate more accurate analysis and cross-comparison among various divisions because it differentiates between certain revenue-generating activities. Companies can use profit centres to determine the future distribution of available resources and may allow management to cut some activities completely.
The managers or executives in charge of profit centres might face pressure to ensure their division's products or services sales outweigh costs. They may have decision-making authority related to product pricing and operating expenses, so they have responsibility for ensuring the profit centre produces profits every year by increasing revenue and decreasing costs.
Why are profit centres important?
Here are some of the reasons profit centres are essential:
If a dedicated department in a company works to produce business profits, the company might take further risks in other areas. For instance, it may allocate profits that another division generates to invest in a new service or product that may lag in creating its own profits. The company may intend that the new product eventually develops into its own profit centre.
When companies use profit centres, their other divisions can focus on lowering expenses to stabilize their profits, including overhead costs. Instead of all divisions concentrating on activities that produce revenue, some departments might focus on limiting spending. Creating profit centres helps identify which departments can focus on cutting costs and reduces the pressure to generate additional revenue.
Using a profit centre allows other departments and the centre to have independent financial records. Keeping separate financial records can help a company identify other areas that function well or accrue higher spending. The information that segmenting costs provides can help a company create strategic plans for the future.
Profit centres can help businesses identify how much their product departments spend on producing goods and the amount they can net through profits. This information can assist when budgeting and forecasting and help the company decide how to distribute future funds, allowing it more confidence in its decisions based on the information and potentially reducing the chance of underestimating future costs.
Elements to consider when creating profit centres
There are several considerations a company's leadership may make to launch a profit centre into a business successfully, and they can customize these for their needs and goals. Here are some components to consider:
Financial record management
Companies create periods to update their profit tracking, such as annually or quarterly. This process allows the finance department to track profits and expenses for a specific product within that period. Combining or eliminating amounts in each financial record using the profit and cost centres may be necessary if the organization decides to restructure by combining or removing certain products or departments. There are many accounting programs available that finance teams can use to enter planned costs and revenue estimates to record the actual amounts as pay you or earn.
Financial record creation
Each product division within an organization can create its own profit-and-loss statements to understand where it's earning the most money. For instance, the accessories department in a retail store might include various revenue sources and expenses like utilities and wages. Combining these figures provides each department with a net profit figure. When accountants look at the finances with designated profit and cost centres, it helps them identify potential opportunities to make budget shifts or invest in diverse areas.
Cost and profit creation
An organization decides the areas of the business that it considers profit and cost centres. For example, the editorial department of a publishing company may require development costs and freelance expenses, which are direct and necessary expenses that may not produce revenue. Other activities considered in cost centres may also not create any income, including inventory management or customer service. Companies might use specific sales departments as profit centres because they create a direct profit in each product area.
In advance of a company's accounting department reallocating costs and profits in a restructured model, the business may require a realignment of its spending. Each product can have its own vertical alignment, meaning it manages its own profits, losses, and operating costs, which can help with the change. For example, each product department might oversee its earnings and expenses in different areas, like marketing and design.
Revenue and overhead
The creation of profit centres can be more beneficial to some companies than others. The profit centre model might be an option for a company with multiple product types that produce different revenue and expense amounts. Many companies may divide their accounting and organizational structure by function rather than division. An organization may consider restructuring with the goal of understanding each department's particular profit and loss and how it might reallocate expense budgets or profits for investments.
Profit centres vs. cost centres
Profit centres are not necessarily suitable for tracking all departments in an organization. This particularly applies to departments that deliver an essential service for the business. Companies may not consider the following as profit centres:
Broker-dealer's research department
Law firm's compliance human resource/auditing department
Clothing retailer's inventory management department
Customer service and human resources department
Managers and executives belong to departments with their own expenses but don't personally generate any revenue as cost centres. Profit centres operate with an emphasis on generating revenue, and cost centres do not focus on the direct production of profits. Cost centres include numerous departments that provide support, such as customer service, human resources, and IT support. These departments are essential to how a business operates, but they don't have a direct duty to make money.
Examples of profit centres
Here are some examples of profit centres:
Here's an example of profit centres in a large retail enterprise:
McLarty Enterprises has a wide variety of profit centres, from clothing to cosmetics and electronics. To analyze revenue sources, the company may isolate the funds generated from the women's clothing department from the men's clothing department or another department entirely, such as the electronics department. Separating the finances this way allows the company to examine and compare the profitability of different products based on associated cost and revenue comparisons.
The concept of a profit centre is an outline to support optimal resource distribution and profitability. To maximize profits, management may decide to distribute more resources to highly profitable areas and reduce distributions to less profitable or loss-inducing units.
Here's an example of a profit centre in a technology company:
Mollison Tech Inc. analyzed its income and overhead and realized that its laptop computers generated the most significant profits. Its network technology products and services had the most significant expenses. The company reorganized their business areas so each can have its own product centre, including phones, virtual reality, network technology, and laptops. The accounting department created a profit and loss form for each area. The laptop centre earned $700,000 in revenue. The expenses were $200,000 in utility costs, wages, and device management for February, showing a profit of $500,000 or a profit margin of 71%.
The network technology products and services profit centre reported $60,000 in revenue and $54,000 in costs, earning a profit of $6,000 and a profit margin of 10%. The management team is investigating ways to reduce expenses and increase company profits. For example, the company may use the extra profits from the laptop sales to finance new hardware for the network technology profit centre.
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