What’s the Difference Between a Cost Centre and a Profit Centre?

wpid-wpid-wpid-PL-Review-Action-Plan-Diagrams-001-003-300x160-2011-02-20-01-27-2011-02-20-02-27-2011-02-20-02-27.jpgLet me start this entry by being upfront. I am neither an economist nor do I have an MBA, so what I say here will be simplistic and probably rather crude. Likewise my sources of information are basic and cursory, but here goes.

At the heart of any organisation is a model of the way that it creates value. It might be gutting chickens, or it might be selling financial services, or it might be educating people on degree courses. Somehow, the organisation takes a raw ‘product’ or ‘service’ and turns it into something of value or increased value. This can be raw commodities or it can be speculative information, all the same, value is recognised and accounted for most often through the profit and loss account of the company.

So, what is value?

“Many managers have distinguished themselves by tightly managing their operations, focusing heavily on building in operational efficiencies, while always maintaining a close watch on their budgets. Often they will do whatever it takes to keep costs down while maintaining good service to their customers. And isn’t that what they are hired to do?

Innovation and improved performance don’t happen by accident. It requires investment and managers who are always focused on reinvesting in their organisation.

Good managers identify problems and then solve them. If there is a defect, they fix it. If there is a deviation, they right it. While this is essential, it merely maintains the status quo and frankly, in an ever-changing environment, those who stand still, fall behind.

Great leaders are always looking around the corner, identifying emerging trends and potential opportunities, and then are seeking ways to take advantage of these for the betterment of the business. They are raising the bar — driving the performance of their organisation and their people to the next level.

Leaders zero in on activities that create real value for the organisation by investing in those things that add value–whether it’s people, systems or equipment. While systems and equipment are important, we must first focus on people. Without people, we have no operations. Yet recently, I spoke with a manager who strongly believed her job was to vigilantly search for ways to cut costs — a task for which she was very adept. Unfortunately, her good work has resulted in an organisation that struggles to recruit and retain people, and the employees she has are unprepared for the challenges of the 21st century” (ezinearticles).

Within this process, then, there is a way of dividing up where that value is created in an organisation. So, different parts of the organisation, and different parts of the value generating process are seen from different perspectives along the value chain. They are seen, in turn, as cost centres, revenue centres and profit centres.

Cost Centre: is that department of a company whose manager is responsible for cost spendings only – like production departments.

Revenue Centre: is that department whose manager is only responsible for revenue – for example sales department.

Profit Centre: is that department whose manager responsible for cost as well as revenue of department. That department is called profit centre like “Autonomous Business Units” (wikianswers).

wpid-wpid-wpid-image824-300x224-2011-02-20-01-27-2011-02-20-02-27-2011-02-20-02-27.gifThe question within any business, then, is how we understand and decide where value is created within an organisation, and most importantly, who can lay claim to being the chief progenerator of that value? Running a successful business unit is dependent on both your profit and loss account, but also the way that your profit and loss is perceived. An R&D department has a licence to spend money because it’s value is realised elsewhere in the value chain, with the development of new products, new production techniques, and new ways to integrate technological innovation. Alternatively, the sales team is seen as a revenue centre because it interfaces directly with the clients and is the point where cash is handed over in exchange for goods and services, contracts are signed, and relationships are formed. The sales force, however, are completely dependent on appropriate and market-ready products that are thought desirable by the public. But while the sales team doesn’t create any products, they are still regarded as the primary drivers of income, and the point in the value chain where units are shifted or people sign-up to extended service plans.

Realising value is therefore said to be achieved as a calculus in relation to the following three factors:
Where are the costs?

Where is the revenue generated?

Where are the profits accumulated?

Further analysis of the perceived value chain in any organisation will likely have some ramifications for the way that each of the activities undertaken in the various stages of the value chain are measured and defined. So those parts of an organisation that are recognised as being ‘profit’ centres are usually considered as essential, and are given an appropriate institutional status and weighting, especially when they are turning a profit relative to their costs. Those that are considered a cost centre, by contrast, are therefore consistently squeezed and managed so as to keep costs under control, without being able to share in the recognition that they too contribute to the overall accumulation of value, and thus profit for the organisation. So:

“One thing we can [easily] forget in our business as leaders is that our activities (and ultimate results) are a result of our attitudes. From our attitudes and activities, our staff (and customers) reacts to those attitudes and activities with behaviours that affect whether or not our benchmarks are met… It sounds old-fashioned – but we need to reconsider the basics: putting our benchmarks where our business drivers are. To be successful with customers into this new millennium we must redirect our efforts from being inwardly focused to being outwardly focused. Because, if we don’t – someone else will!” (callcentres.net).

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