In simple terms, the profit center can be defined as the section of a business that would yield gains on top of expenses. This is the unit within the business for which both the revenues as well as expenses are recorded. A profit center can be simply an organizational unit in accounting that would reflect a management-oriented structure of any business that has been created for the purpose of internal control.
Importance of Profit Centers:
It is important that the profit center is managed carefully in order to make sure that the sales generating activities would lead to increased revenues in comparison with the cost of those activities, thereby producing a profit. Developing a separate profit center within an organization would allow the management to assess the profitability of each activity.
Profit Center vs. Cost Center:
Each and every company will have cost center in addition to the profit center. The cost center can be defined as the business unit which would provide necessary services without generating any revenue to the company.
In the recent times, the term ‘profit center’ has taken a new meaning – search for higher profits by pressurizing the functions that were shielded from the market before. This meaning has been adapted as the companies have attempted to convert the service units into profit centers based on the following criteria:
- Charging for the services that are rendered to other departments (i.e., internal customers)
- Selling a part of cost-center outputs to external customers for the purpose of generating revenues
Transforming a Cost Center into Profit Center:
It may sound weird to some people out there. But, it is to be remembered that all the cost centers would do something and hence, they would have something to advertise and market. Thus, theoretically the HR department of a company could be transformed to act as a recruiting company by creating marketing strategies of its own and by losing its identity as a service provider to the internal customers only.
As you may see, certain functions of a company like IT would seem more ideal to fit the concept of this transformation. This is because; only little is required for this conversion with an exception of the inclusion of a function of selling. For example, management of external databases will be the similar to the management them in-house when functionally considered. Other functions that could have analogical advantages are:
- Modeling departments
- Product design
- Product testing
The advantages of converting the cost center arise from the expectation that the expenses for the particular function would decrease with the passage of time thereby making the business more profitable than ever before. Thus, the previously known cost center of the company would become more efficient as well as responsive under the competitive pressure. In addition, this conversion would largely increase the total revenue, if externally successful.
The disadvantage of a profit center arises from the point that each and every business is an organization and hence, both profit center and cost center are the essential organs of any company with these centers having the characteristics that are evolved for making them work together.