Cost Center and Profit Center are very crucial business concepts that contribute immensely to an organization’s success. These both are the responsibility centers of an organization. Even though both these approaches are different, they work towards the same objective of making business more successful. Thus, it is very critical to understand the differences between profit center vs cost center.
Before we detail the differences between profit center vs cost center, it is important to understand what these two concepts mean.
- Profit Center vs Cost Center – What They Are?
- Profit Center vs Cost Center – Differences
- Final Words
Profit Center vs Cost Center – What They Are?
A cost center is a business unit that does not generate revenues but does incur costs. Of course, it helps the company’s smooth functioning by incurring and minimizing costs. The General Repairs and Maintenance Department of the company can be one of the best examples of a Cost Center. Such a department incurs costs to maintain the equipment, machinery, and facilities of an organization. Other examples of cost centers are the accounting department, the human resources department, the customer service department, etc. An organization evaluates the performance of a cost center by comparing the cost that it incurs against the budgeted cost.
On the other hand, a profit center is a business unit that generates its own revenues and does make profits too. A profit center uses all its business resources available at its command to maximize its revenue and profits. Such a business unit has its own costs as well. The sales department of a company is the best example of a profit center. Management evaluates the performance of a profit center on the basis of the profit it generates.
Now that we know what cost and profit centers are let us take a look at the differences between profit center vs cost center.
Profit Center vs Cost Center – Differences
Below are the key differences between profit center vs cost center:
The cost center is a department or a sub-division in a company that manages cost incurrence and controls the costs. In contrast, a profit center is a department or sub-division aiming to maximize revenue and profits.
Contribution to Revenue
The profit center is responsible for generating as well as boosting the revenue of the organization through direct operations. Whereas a cost center only incurs the costs and has no direct contribution to the bottom line/profits of the company. But, a cost center definitely indirectly contributes to revenue. Because it helps to ensure the organization runs smoothly and is able to carry out its core operations.
Management can segregate cost centers into sub-divisions on the basis of activities being carried out by that particular division or unit. These activities could be customer relations, human resources, employee relations, and more. On the other hand, management can segregate profit centers using sales-related parameters. These parameters could be different products, product categories, product lines, and more.
Cost centers support activities and operations that help a business generate revenue. Cost centers are thus a facilitator. On the other hand, profit centers are directly responsible for generating revenues and profits for the organizations.
Role of Management
With a cost center, management works to lower its costs while ensuring that its activities do not get affected adversely. With a profit center, management works to boost the units’ revenue generation capacity while keeping tight control on the costs so as to maximize the profits.
Role of Department Heads
In a cost center, the head is responsible for ensuring the costs do not exceed the pre-defined limits/allocated budgets. And in a profit center, the head is responsible for decisions pertaining to pricing, production, and other crucial matters of the unit with the ultimate objective of achieving greater revenue and profits.
The performance evaluation of a cost center by the management happens by comparing the actual costs incurred vis-a-vis the costs allocated or budgeted. For a profit center, management evaluates its performance by comparing the actual and budgeted costs for a particular revenue level on the one hand. And by comparing the actual revenue and profits generated by the center vis-a-vis targetted ones.
Since the activities of a cost center are concerned only with the costs, it is very easy to analyze its activities. However, it could get challenging to analyze the activities of a profit center as it concerns both the costs and revenues.
A cost center is crucial for management accounting as it assists in collecting cost-related data. Management then uses the data for preparing budgets and other internal reports, as well as controlling costs.
In contrast, a profit center helps in accumulating profit-related data. Management then uses the data for decisions on production, pricing, and sales.
Cost centers are generally organizationally simple. Profit centers, on the other hand, usually possess a complex structure.
A cost center’s area of influence is relatively narrow, while for a profit center, it is substantially wider.
The cost center is driven with the approach to ensure the long-term sustainability of the business by reducing and controlling the costs to a reasonable level without affecting the performance of the company. At the same time, a profit center aims to ensure both short- and long-term profitability of the business by maximizing revenue and profits from available resources.
Generally, the profit center is bigger than the cost center. In fact, there could be several cost centers within a profit center. For example, if a company has many product lines, it could convert each product line into a profit center. In this case, each product line could have one or more cost centers, such as an accounting department, IT department, etc.
Types of Cost and Profit Centers
Profit centers can be of two types:
- A department within an organization and
- An independent entity.
However, profit centers can be of many types. But the main ones are: production cost centers, service cost centers, and administration and sales cost centers.
Examples of a cost center are – The human resource department, research, and development department, customer service department, and more.
Examples of a profit center are – Sales departments, a subsidiary, and more.
From the above differences, it is clear that the profit and cost centers are very crucial for a business. Even though a cost center does not generate any revenue, without its support, a profit center may not be able to work properly. Also, even though most stakeholders primarily look at the performance of the profit center, it will get very hard for management to sustain the operations for the long term without support from cost centers.