Reviewed by Aug 27, 2020| Updated on
A profit center refers to a branch or unit or division of a company which directly adds or which normally adds to the bottom-line or profits of the company as a whole. The term cost center was coined by Mr Peter Drucker. An organisation considers a profit center as a separate unit, standalone business which is responsible for revenue generation and profits. An organisation calculates the profits and losses of a profit center separately.
Understanding Profit Center
With the creation of profit centers, an organisation differentiates between different revenue-generating activities. Profit centers are critical for determining the units which are the most profitable and the ones which are least profitable in an organisation. The profit center wise analysis enables accuracy and a comparison between divisions. The division wise analysis helps in determining allocation of resources as between profit centers, and also determines which activities can be cut down and which need a boost. The managers of individual profit centers have decision making authority with respect to the pricing of products and managing operating expenses. Each manager is responsible for the performance of their profit center. Hence, it is necessary that the managers identify wasteful activities and cut down the same. The managers can also alter the nature of activities or increase the bandwidth for certain activities. On an overall basis, the managers need to increase the sales and profits of their division. A particular grocery chain can divide different departments selling different products into profit centers, making their individual managers accountable for the progress of their division. The grocery chain can consider vegetable oil and body shop segment as different profit centers. Similarly, companies in the information technology space can consider packages software and ITES as separate segments.
An organisation should bear in mind the activities carried out in each center before categorising it into a profit center. In each organisation, there are support service departments which do not carry out any profit-generating activities. Such departments are not profit centers, however they are essential for the organisation.