Every activity or performance carried out by the company has certain indicators to be said to achieve success, whether it is achieving sales targets, increasing return on investment, increasing customer acquisition, and others.
A profit center is a department that is responsible for the management of company profits or profits.
Later, the results of the profit center’s performance also need to be evaluated, whether it has reached the target or there is a need for a strategy to improve it. Like a balance sheet application that can help your business.
To understand more, let’s see the discussion below!
Understanding Profit Center
A profit center is a department that has the responsibility of generating profits or profits directly. Generally used by companies that have many separate businesses such as Unilever and Paragon.
They will keep expenses to a minimum but can also generate maximum profit.
Profit center will help companies in budgeting, generating profits, increasing return on investment, and collecting data for decision-makers.
By type, a profit center can be a department or an independent entity.
Jenis Responsibility Center
A company’s decentralization policy can be based on determining the type of responsibility center.
What are the types of responsibility centers?
- Revenue Center
In the revenue center, the manager is responsible for achieving revenue for the team or subsidiary. One example of a revenue center is the sales department or sales.
In this department, the manager will manage the channel and sales in order to get maximum revenue.
Not infrequently managers will have targets from sales, winning rates, customer acquisition, market share, turnover rates, loyalty rates, and others.
- Profit Center
If the Profit Center type, the team manager will be responsible for managing costs. Examples of Profit Centers such as marketing, IT, production, procurement, HR, and others.
Costing within the company can be in the form of discretionary and engineering costs. Discretionary costs are costs that arise because there is a policy from the company.
Examples of discretionary costs are training costs, technology development, marketing and advertising, planning, and so on.
While engineering costs are variable costs and direct costs for certain objects such as direct labor or building rental costs.
The Department Profit Center has success indicators such as budget efficiency and effectiveness, whether the costs incurred are too large or indeed few but the results are maximum.
- Profit Center
In this type of profit center or profit center, the department manager has responsibility for achieving profits or profits earned.
Profit is obtained when the income is greater than the expenses and expenses incurred.
Examples that we often encounter from profit centers are Unilever and Indofood, they have many products of their own in the company. Indicators of success are profit targets, profit margins, or profit growth.
- Investment Center
If in the previous type the manager was responsible for achieving profit, in this type the manager also has indicators on the assets or capital owned by the company.
An example of this type is when a company makes plans and strategies for its subsidiaries. Its success is in return on assets, return on investment, return on equity, and economic value-added.
Profit Center Type
Profit centers vary in how independently they are run by an organization. The types of profit centers include:
- Departments within the organization: A profit center can be an internal department that generates revenue, including a sales department.
- Independent entity: A profit center can also be a separate, stand-alone business that generates revenue for the organization, such as a repair shop in a bicycle shop.
Profit Center Performance Evaluation
The profit centers division needs to be evaluated for its performance. Generally, the measure of the success of the division is the achievement of profit. There are two ways the company uses to calculate profit in this division, namely absorption costing and variable costing.
The difference between the two methods of calculating profit is only in the way fixed factory overhead costs are treated.
Profit calculation using absorption costing, all product costs, both variable costs, and fixed costs are included in product costs.
On the other hand, in calculating profit using variable costing, only variable production costs are included in the calculation of production costs.
Meanwhile, fixed overhead costs are included as periodic expenses.
Included in the examples of variable costing production costs are direct material costs, direct labor costs, and variable overhead costs.
While absorption costing production costs include direct material costs, direct labor costs, variable overhead costs, and fixed overhead costs.
The difference in the use of cost to calculate profit is affected by units produced and units sold.
When the units produced are larger than the units sold, then the calculation of profit using absorption costing will be greater than the profit calculated using variable costing.
On the other hand, if the units produced are smaller than the units sold, the profit calculated using absorption costing will be smaller than the profit calculated using variable costing.
Profit will be the same between calculations using absorption costing and variable costing if the units of production are the same as the units sold.
Performance measurement of profit centers is often also measured using segment reporting. Companies that have several business units are measured for their performance by segment reporting.
The principle of segment reporting is the grouping of fixed costs into direct fixed expenses and common fixed expenses.
Direct fixed costs can be traced directly (directly traceable) to each segment, therefore these costs are costs that can be avoided (avoidable expenses).
This means, if a certain segment is eliminated, for example, because the business or product prospects are not profitable, then the direct fixed costs of this segment can be eliminated.
Importance of Profit Center
- Establishment of a responsibility center
Costs are clearly identifiable and separate units or departments with their own set of responsibilities and tasks.
Each of them is individually accountable to management for their activities, expenses, and results.
They cannot pass their failures on to other cost centers, and allow them to be identified separately. Therefore, it becomes easy for the management to check and analyze the activity of each Profit Center separately.
- Improved operational efficiency
As said earlier, Profit Centers have their own set of duties and responsibilities which are carefully planned and designed by the management.
Therefore, there is a proper distribution of responsibilities, which leads to the creation of synergies between different departments.
There is an increase in efficiency in the organization as each department is clear about its respective scope of work and availability of resources.
This helps in gaining customer trust and confidence, as well as providing enhanced product value. Also, employee trust and satisfaction can be achieved, which is very important for the success of every department and organization.
- Better implementation of innovation and technology
Companies can use the latest process-oriented technology tailor-made for individual Profit Centers.
It is easier to implement new methodologies and innovations with the work assigned to each Profit Center. This results in increased efficiency, higher output, and profitability for the company.
- They improve the customer experience
The customer service department is used to help customers resolve complaints, find products, and understand company warranties or policies.
Excellent customer service builds company value and can create a loyal customer base.
- They maintain buildings and equipment
IT departments, maintenance workers, and cleaning staff help ensure that all company equipment is running properly and facilities are clean and safe. These workers ensure you can make a profit and help keep your staff healthy.
- They do research and development
The research and development department finds innovative solutions to consumer problems and designs new products.
- They perform data analysis and develop business strategies
The data and market analysis department helps you understand consumer trends and changes in your industry. These departments give you the information you need to see how effective your current business strategy is and what you should change going forward.
- They manage administrative tasks
These roles include office staff, human resources, and accounting departments. They ensure that your company submits reports and forms accurately and manages payroll and budgeting and organization in the office, and completes many other important administrative tasks.
Profit Center Performance Example
The results of the work of the profit center can be done by comparing the budget plan with the actual costs that have been spent. For example, toddler snack products make a budget of 50,000,000 for operating costs and store renovations.
If the actual expenditure is less than 50,000,000 it means the store is doing well but if the cost is more than 50,000,000, the profitability of the business needs to be evaluated.
Examples of profit centers are souvenir shops in hotels, special departments in supermarkets, certain product lines in manufacturing companies, cafes in hospitals, and so on.
Profit Center expense center. If not managed properly, they can be a drain on limited organizational resources. Since the work is spread across separate departments, each of them requires personnel and incurs overhead costs.
Hence, they can prove to be expensive as expenses will increase with each additional department.
On the other hand, if a company chooses to work without a different Profit Center, it will require less manpower. Also, the set-up and overhead costs will come down considerably.
Negative impact on efficiency and productivity
Individual Profit Centers do not by themselves generate profits but incur costs. Therefore, it is not easy to assess and determine their contribution to the company’s overall profitability.
In other words, financial achievements do not reflect; otherwise, it is not noticed. Also, some Profit Centers may incur high expenses and be the target of criticism within the organization, even though they may contribute positively to productivity and profitability.
Such examples lead to the morale of the employees, leading to a loss of efficiency and productivity.
Then the difference between Cost Center and Profit Center is:
A company is made up of a collection of units, divisions, and sections known as operating units. Some units generate large revenues and profits for the company while some units generate costs and expenses.
However, both types of operating units are profitable and can generate profits either directly or indirectly.
Profit Center like the sales division is a profit center that is responsible for a large number of company profits.
Cost Centers such as research and development, marketing, customer service, IT, and maintenance generate large short-term costs, but without these departments, enterprises cannot generate long-term profits;
Therefore cost centers are very important for the smooth and long-term profitability and success of the business.
Cost centers or cost centers and profit centers exist in decentralized companies, which delegate decision-making to lower-level managers rather than relying on top executives to make all company decisions.
Both types of centers incur costs to operate, but only profit centers generate revenue.
Profit centers and cost centers work to reduce costs. Cost centers focus on long-term success through a sustainable cost savings approach while profit centers are more concerned with creating strategies for short-term revenue.
Each product line may depend on the following cost centers:
- Maintenance department
- Accounting Dept.
- IT Department
The type of in-depth and specific information produced by the cost center is usually most useful to internal sources than external sources.
For example, it is irrelevant for tax authorities to know the salaries of company maintenance staff.
- Companies use cost center data for internal tasks, such as:
- Making departmental budget changes
- Evaluating spare parts suppliers
- Create a marketing plan
- Defining processes and protocols
- Improve product quality
Information provided by profit centers helps organizations make broad financial decisions, including:
- Pricing strategy
- Investation decision
- Staff change
- Remove or add products and services
Profit Center Conclusion
That’s a complete discussion of the cost center and profit center in a business.
The separate division and accounting of the various departments, projects, and business activities must be managed carefully to ensure that sales activities generate more revenue than expenses from each department, project, or business unit.
Creating and calculating separate profits and losses within the company also allows management to evaluate the profitability of each department, project, or business activity separately.
To make this calculation easier, you can use the best accounting software, Jurnal by Mekari, with the warehouse stock application feature that can monitor the profit or loss of business transactions.