- Cost Centre – Do not generate revenue. For example, the IT Department and the HR Department.
- Profit centre – It generates revenue. For example, the Sales Department.
In the modern corporate business, the organisation has multiple departments. Among them, some of the units of departments are developed as cost centres. These incur costs but do not generate revenue directly. Such cost centres are developed as the cost-minimising unit.
The main purpose of developing the unit as a cost centre is cost control efficiency and supporting the other units or departments. For eg. IT department, the HR department, the maintenance department, the internal audit and compliance department, etc., are the cost centres.
Where each of these departments does not generate revenue directly but supports the other revenue-generating departments. The development of a department or unit has multiple benefits, and the major ones are:
- Cost control/minimisation
- Operational efficiency
- Supports revenue-generating departments or units
- Better planning and budgeting
- Performance evaluation based on efficiency or cost of the units.
Profit Centres
If the organisation has developed some level of department or unit for generating revenue and profits, they are profit centres. The profit centres directly generate revenue for the organisation. For example, the Sales department, credit department, deposit/treasury department, branch office, LC department, etc.
Such profit centres have the authority over the cost, revenue, and profit, and they try to maximise the profit.
There are multiple benefits of developing the department or unit as a profit centre, such as:
- Decentralised decision making.
- Improves accountability and probability.
- Strategic resource allocation.
- Encourages innovation and competitiveness.
- Improved performance measurement.
Reasons to divide cost centres and profit centres within a business organisation
1. Specialisation: The classification into profit and cost centres allows each unit to focus on its primary functions, such as revenue generation or cost reduction.
2. Competition and efficiency: The division of the units as the cost or profit centres encourages them to compete with each other, which results in improved efficiency of the organisation.
3. Decentralised Decision Making: The profit or cost centre has its own priority, and it can make its decision accordingly. This improves the decision-making and its execution within the organisation.
4. Managerial accountability: The classification into cost centre and profit centre assigns responsibility to the manager in their respective area. This improves the managerial accountability.
5. Better Internal Control: The classification into the cost and profit centres improves monitoring, reporting and internal audit.
6. Supports Strategic Planning: Profit centres help in long-term strategy, while cost centres support operational planning in the short-run.
7. Performance Benchmarking: The division into cost and profit centres helps to assess their performance in terms of cost or profit.
8. Improve the efficiency and productivity of the organisation: Each cost centre or profit centre works independently to achieve its own objective, which improves the efficiency and productivity of the organisation.
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