Question

 

1. Describe a cost center, profit center and investment center. Which do you think is the most important to monitor and why?
2. If you were the Chief Executive Officer of a multi-branch or multi-departmental company, your company may have cost centers, profit centers, and investment centers. What kind of reports and data would be most important for you to review and analyze on a daily, weekly, and monthly basis, and why? Which center is the most important to you, from a managerial standpoint?

Answer 1

Cost Centre

                        A cost center is a department or function within an organization that does not directly add to profit but still costs the organization money to operate. Cost centers only contribute to a company's profitability indirectly, unlike a profit center, which contributes to profitability directly through its actions. Managers of cost centers, such as human resources and accounting departments are responsible for keeping their costs in line or below budget.

1. A cost center is a function within an organization that does not directly add to profit but still costs money to operate, such as the accounting, HR, or IT departments.

2. The main use of a cost center is to track actual expenses for comparison to budget.

3. A cost center indirectly contributes to a company’s profit via operational excellence, customer service, and enhanced product value.

4. The manager for a cost center is only responsible for keeping costs in line with budget and does not bear any responsibility regarding revenue or investment decisions.

Obviously most business units incur costs, so this alone does not define a cost center. A cost center is perhaps better defined by what is lacking; the absence of revenue, or at least the absence of control over revenue generation.

Human resources, accounting, legal, and other administrative departments are expensive to support and do not directly contribute to revenue generation. Cost centers are also present on the factory floor. Maintenance and engineering fall into this category. Many businesses also consider the actual manufacturing process to be a cost center even though a saleable product is produced (the sales "responsibility" is shouldered by other units).

It stands to reason that assessments of cost control are key in evaluating the performance of cost centers. This chapter will show how standard costs and variance analysis can be used to pinpoint areas where performance is above or below expectation. Cost control should not be confused with cost minimization. It is easy to reduce costs to the point of destroying enterprise effectiveness. The goal is to control costs while maintaining enterprise effectiveness.

Nonfinancial metrics are also useful in monitoring cost centers: documents processed, error rates, customer satisfaction surveys, and other similar measures can be used. The concept of a balanced scorecard is discussed later in this chapter, and it can be very relevant to evaluating the performance of a cost center.

Profit Center

A profit center is a branch or division of a company that directly adds or is expected to add to the bottom-line profitability of the entire organization. It is treated virtually as a separate, standalone business, responsible for generating its revenues and earnings; its profits and losses are calculated separately on accounting balance sheets.

1. A profit center is a branch or division of a company that directly adds to the corporation's bottom-line profitability.

2. A profit center is treated as a separate business, with revenues accounted for on a standalone basis and balance sheet.

3. The opposite of a profit center is a cost center, a corporate division or department that does not generate revenue.

Some business units have control over both costs and revenues and are therefore evaluated on their profit outcomes. For such profit centers, "cost overruns" are expected if they are coupled with commensurate gains in revenue and profitability.

A restaurant chain may evaluate each store as a separate profit center. The store manager is responsible for the store's revenues and expenses. A store with more revenue would obviously generate more food costs; an assessment of food cost alone would be foolhardy without giving consideration to the store's revenues. For such profit centers, the flexible budgets discussed in this chapter are particularly useful evaluative tools.

                      The concept of a profit center is the development of a framework to facilitate optimal resource allocation and profitability. To optimize profits, management may decide to allocate more resources to highly profitable areas while reducing allocations to less profitable or loss-inducing units.

Investment Center

An investment center is a business unit in a firm that can utilize capital to contribute directly to a company's profitability. Companies evaluate the performance of an investment center according to the revenues it brings in through investments in capital assets compared to the overall expenses. An investment center is sometimes called an investment division.

1. An investment center is a business unit that a firm utilizes its own capital to generate returns that benefit the firm.

2. The financing arm of an automobile maker or department store is a common example of an investment center.

3. Investment centers are increasingly important for firms as financialization leads companies to seek profits from investment and lending activities in addition to core production.