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Profit Center

A profit center is a unit of a company that generates revenue in excess of its expenses. It is expected that, through the sale of goods or services, the unit will turn a profit. This is in contrast to a cost center, which is a unit inside a company that generates expenses with no responsibility for creating revenue. The only expectation a cost center has is to lower expenses whenever possible while staying with a specific budget that is determined at the corporate level.

Beyond that simple definition, the term "profit center" has also come to represent a form of management accounting that is organized around the profit center concept. Companies that have adopted the profit center system have organized all of their business units as either profit centers or cost centers, and all company financial results are reported in that manner. Adopting a profit center system often requires a radical shift in corporate philosophy and culture, but it can yield great returns in net before tax (NBT) profits. According to an article in Business Solutions, the data collection company Data Recognition, Inc. made the shift to a profit center-based system and was pleased with the results. "We saw the importance of evaluating, individually, areas of our business that are distinctly different," said Steve Terry, the company's vice president of systems. "The profit centers have allowed us to better identify specific gains and losses. And that's critically important for a growing business."

All companies, no matter what size, have both cost and profit centers (although, if it is a single-person company, that company would really have profit and cost activities, since all business "units" are the same person). For example, in most companies, units such as human resources and purchasing are strictly cost centers. The company has to spend money to operate those units, and neither has any means of producing a profit to offset those expenses. They exist solely to make it possible for other areas of the company to make money. However, without those two departments, the company could not survive. Examples of profit centers would be the manufacturing units that produce products for sale to consumers or other businesses. The sale of those products generates a profit that offsets the expense of creating the products.

All companies have profit centers and cost centers, but not all companies organize their accounting practices around the profit center concept. In fact, most companies do things the time-honored way, producing overall profit and loss statements for the company as a whole, without making each business unit accountable for generating a profit.

Turning a Cost Center Into a Profit Center

A cost center may actually provide services that could generate a profit if they were offered on the open market. But in most corporate environments, cost centers are not expected to generate a profit and operation costs are treated as overhead. Departments that are typically cost centers include information technology, human resources, accounting, and others. However, the complacent acceptance that some departments will always be cost centers and can never generate a profit has changed at some companies. They recognize that cost centers can turn into profit centers by taking the services they used to automatically provide to the company's other business units and making those services available for a fee. The company's other business units are then required to pay for the services they used to get for free. But in return, they are allowed to go outside the company and contract with another firm to provide those services. Likewise, the former cost center may be allowed to sell its services to other companies. The expectation is that this free market system will improve performance through increased competition while increasing profits by turning former cost centers into profit centers.

"When a business firm becomes a corporate community of entrepreneurs who buy, sell, and launch new products and services internally as well as externally, it gains the same creative interplay that makes market economies so advantageous," said management professor William E. Halal when discussing making the move to profit center-based operations in USA Today Magazine.

As an example of how a cost center may be turned into a profit center, consider a company's information technology (IT) department. This department may provide such services as computer-aided design, network administration, or database development to other units of the company. These services have value, and they are important to the company's overall success, but they do not generate a profit. IT may charge the "cost" of its services back to the department that requested them, but it does not make a profit because it charges only for its actual costs incurred, without adding an extra margin for profit. The unit that requested the services absorbs the cost as part of its overhead; or, in some companies, the cost is not charged back and is simply part of the company's overall overhead.

There are two ways that the IT department could make the switch from cost center to profit center. First, instead of writing off its services to overhead or charging them at cost, the IT department could be allowed to bill other departments for its services at going market rates. The profit earned for the services would exceed the cost of providing the services. While all the money in this transaction would stay within the company, thus making it seem to be a meaningless way of creating a profit for the IT department, it is done for two reasons. One is to ensure that the IT department remains competitive with outside vendors providing the same services, and the other is to ensure that the company's other business units do not waste money on needless IT expenditures. Paying competitive market rates prevents the operating units from wasting money, thus making them more competitive.

If the IT department is turned into that type of profit center, it is considered to be a "zero profit center." In that situation, the department is expected to compete with outside vendors for the company's information technology budget. If a division of the company selects the IT department as its technology provider, it has done so because it feels it cannot purchase the same quality services for a lower price from an outside vendor. It will not actually "pay" the IT department for its services, but it will be charged by the IT department for services rendered, and those charges will be subtracted from the division's budget. Thus, the IT department does not really take in any revenue, but neither does it cost the company any money because the division that utilized its services would have had to spend money to hire an outside vendor. This, then, creates a zero profit center. Such a business model forces the IT department to be more competitive in its pricing and to provide high quality work if it hopes to survive as an operating unit.

The second way the IT department could become a profit center is if the company determined that the department was one of the best in the industry, better in fact than some companies that existed just to provide IT services. The company could then allow the department the freedom to sell its services to outside customers. Thus, the department would still operate as a cost center in its dealings with other units inside the company, but it would operate as a profit center when it provided services to outside companies. This method of operation has become far more common in the 1990s and beyond, as companies seek new revenue streams that have low start-up costs.

If the IT department exists only as a cost center, it faces enormous pressure to provide services at the lowest possible costs. Because it does not generate profits, it must constantly fight to remain in existence and must fight off attempts to slash its budget to free up cash for the company's profit centers. Just as the company's senior management could decide that the IT department was good enough to operate as a profit center by soliciting outside clients, so too could it decide that the department is behind the times and is not providing adequate services. This would result in management choosing to shut down the department and contract with an outside vendor for the company's IT needs.

Profit Centers and Their Changing Role in Industry

In large companies, especially manufacturing companies, it has become a fairly common occurrence to break the company into small pieces, with each piece operating as a profit center that has to compete for business. In this manner, a large business can suddenly find itself operating as a small business. For example, say the Acme Company produces a finished product that is composed of five smaller parts. Instead of operating as one large company that produces all five parts needed for the finished product, Acme has decided to split into six separate units—one that assembles and sells the finished product, and five smaller companies that each produce one of the parts needed for the finished product. Beyond Acme, there are other companies that produce those same five parts needed to produce the finished product.

Each of the five part manufacturers is now operating as a separate profit center, reporting to Acme's corporate office. Each has to determine its own methods of operation, and each has to determine how it is going to show a profit. There may be internal agreements in place that mandate that each of the five units will continue to work together to produce the finished product, or Acme may throw things wide open by stating that there is no corporate mandate forcing the five divisions to continue to work together.

If the latter model is chosen, the corporation may have decided that, while the company could continue making steady—but small—profits if it kept using the five units together as it had for decades, there was a chance that the company could make huge profits if it made each of the five units accountable for its own bottom line and opened up the manufacturing process to both internal and external competition. In such a radical environment, it was conceivable that one of the five units could go bankrupt and cost the company money, but senior management believed that the hugely increased profits in the other four units, and the resulting higher profit margin realized by the sale of the finished product, would more than offset the loss of one unit.

Thus, each of Acme's five units, formerly divisions within the larger company that were not accountable for directly generating profits, were now separate entities that had to show a profit to continue operating. Each of the units had gone from a cost center mentality—buying materials to produce part of a product that showed up on the company's overall bottom line—to a profit center mentality, responsible for showing a profit based solely on the production and sale of its one part. As part of the shift to becoming a profit center, each of the five units would also be free to sell its part on the open marketplace. Acme might make that freedom a restricted one that prevented sales to a direct competitor, or it might take the full plunge and make the unit a fully stand-alone company that was free to sell its part to any other company in the market, including direct competitors. That decision would dictate whether Acme's move was a small one, designed to encourage each of its five units to think creatively and work harder to perform at a high level, or a large one, designed to change the very core of the company's business in a bid for higher profits.

Profit Centers and Small Businesses

When operating a small business, it may not be practical to use the profit center concept initially because the business is so small. Fewer employees mean fewer business units, which means fewer opportunities to create profit centers. In addition, in a small business, the president or the chief financial officer is probably monitoring financial results very closely, which means that he or she knows exactly where profits and losses are occurring. However, as a small business begins to grow, establishing profit centers often makes sense. Data Recognition, Inc. found that switching to profit centers made sense as the company increased in size. "Establishing profit centers, and generating daily profit/loss statements, has allowed us to better identify, and correct, our weaknesses," said vice president Steve Terry.

Even without adopting the profit center accounting concept, the idea of profit centers has value for small businesses in that they should always be looking for new ways to generate revenue. When operating a small business, there are essentially two ways to create a new profit center. The first method is to create an extension of the original business—a new product related to existing products, or new services that build on services that are already offered. The second method is to create an entirely new business altogether that can operate using the first business's corporate infrastructure (at least initially) and that can be operated at the same time as the original business.

The rapid spread of the World Wide Web has created an unprecedented method for creating new profit centers. Almost every company today has a Web site to dispense public relations information and to make it easier for customers to contact the company, but more and more firms are recognizing that there is money to be made on the Web. Most corporate Web sites begin life as a cost center, since they are initially just used to disseminate information, but most can be transformed into a profit center.

When seeking new profit centers, small business entrepreneurs should avoid business models that have regularly failed on the Web. These include setting up an entertainment site that attempts to charge a fee for that entertainment; relying on advertising as a revenue stream, as banner advertisements are proving to be quite unsuccessful in bringing in new customers; charging subscription or other visitor fees; and biting off more than you can handle by attempting to establish business-to-business sales that may not be achievable.

From India, Bangalore
hi, :D
I believe that HR will be a profit centre as long as it is focussed on the changing requirements of the company and honestly works to provide the apt manpower.Otherwise If HR loses focus, it can be the biggest cost center as it will be responsible for the salaries of all wrong people!![/b][/b][/b] :(

From India, Delhi

Extending from Ranjith's excerpts

In my understanding the concept of profit centre - a unit that generates revenue to sustain its expenditures. From that perspective, i would like to address the HR function - transitioning or transforming from a support function to business partner hence moving from cost centre to profit centre.

The HR function can become a specialist centre adopting consultative approach for the services it renders to the organization, which will cover all verticals or SBUs

The consultation for providing all HR initiatives - will be charged by the function (HR) to the specific SBU or organization as an entity and this money is used as consulting charges for the service rendered, will be used as remuneration for the HR associates. Though there is a revenue and expenses invloved between the function/s and SBU/organization, it is intra organization and can be like transfer pricing

This approach would entail the HR function to be a profit centre, if it is priced and managed effectively

Suggestions are invited

From India, Bangalore
I believe that HR is an INVESTMENT centre...in the sense that the company needs to invest money in developing its talent...
Nowadays in SOME ORGANISATIONS it is a profit centre...such that HR department is involved in consultancy activities, providing training to suppliers, career couselling its own employees at a certain cost and in turn thus generates profits for the entire organisation

From India, Pune

I agree with view expressed by all of you. Effectively designed and implemented SHRM initiatives are proved to add value to the bottom line.

Most people will acknowledge that the HR profession encompasses a body of knowledge, expertise and skill that add value to organizations. But intuition doesn’t cut in today’s business world. Executives want proof that HR is a profit maker and not just a cost center. SHRM professionals can do more to actively manage perceptions and promote the good work they do.

Various studies have shown that the 15 to 30 percent of the total value of a company can be correlated to specific human capital practices. The point is that the HR professionals have a choice in terms of how they spend their money and invest in the human capital of the firm.

HR has two ways of looking at building profit:

1) Cutting costs and

2) Helping to generate revenue by implementing right HR initiatives.

Saving money is an ongoing concern of HR but cost saving should not be the primary focus of HR professionals who want to generate value for their companies.HRs focus on maintaining a culture that can ensure growth of business and that employee are creative and innovative enough to get the job done.

HR design and implement initiatives to create an overall culture that is conducive to profit making. Though HR doesn't directly produce revenue HR efforts help to strengthen the bottom line.

Visit this link to read in detail :

HR and Operation: Value added SHRM to Drive profits

Prem Kumar

From India, Hyderabad
Dear all,
It’s an interesting thread to dwell upon.

Very often you see the sales guy bragging on his sales performance in terms of number of clients or additional sales to the Management during Appraisal or increments thereby earning his desired wishes/grants! But HR professionals are unable to quantify their performance in terms of ROI to the Management which often makes them feel like as quid and take whatever the Management dishes out.

Coming to the point – HR is a profit centre depending upon the metrics – for instance recruitment – how many candidates were selected by the process of walk ins or direct approaches of HR vis-à-vis the Consultants. Linking the training programs to the goals of the company is another.

Hence well defined metrics by HR are very essential to justify their existence to the Organization.



From India, Pune
HR is neither Cost Centre nor Profit Centre its symbolic gesture its business imperative....Most of the theoritical justification is steatching argument in the domain of financial impact for each of the HR initiatives doesnot justify its status either as cost centre or profit centre....

This linking HR with financial and accounting metrix is fantacy of Balance Scorecard and HR Scorecard approach of CEO's and Business Authers from Walls Streets....They talk of tangible and intangible assets to measure including intellectual capital and investment on trainign as human capital cost. They discuss leading indicators and lagging indicators then apply logics of accounting to meaure financial worth. All this non-sense CEO & Business Authers gimmicks has brought recession and sub-prime mortguage scam by applying same hypothesis and concepts finally expose the truth.....and resulted in turmoil of world economy and great deep deep economic depression.

Basically the entire conceptual thinking and hypothesis is based on Financial -Engineering which promoted sub-prime mortguage mechanism leading to bankruptcy of major financial instutions. If you don't have tangible money you can not mortguage intengible financial figures based on business projections.

The whole concept is like watchig RAJNIKANT MOVIE and applying your common sense and logics to justify his all actions.......

Let understand nacked fact if business with large workforce has to exist and has to run as major market force to recon with HR has to be there. The market value and goodwill any organizational HR practices can build being reflected in market recognition and acknowledgement as model organization then best HR practices become imperative.


From Saudi Arabia
An effective and efficient HR dept is profit center by utilizing employees potential in a perfect manner that ultimately increase productivity and obviously profit. In case of fail doing so, HR will be cost center.
From Pakistan, Karachi

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