Definition: A profit center is a business unit or segment that generates revenues and incurs costs. In other words, it’s a department that uses company resources to generate income. You can think of this as a segment that earns money or creates sales for the business.
What Does Profit Center Mean?
Management separates all company departments into two categories, profit centers and cost centers, in an effort to evaluate each segment’s performance and the effectiveness of its management.
An example of a profit center is the selling or sales department. This business segment uses company resources like rent, sales staff salaries, and utilities to generate revenues by selling products to customers. Management typically analyzes the performance of both the department as a whole and its manager. Both are evaluated on the amount that center revenues exceed costs for a period. In other words, higher-level management tends to focus on the net income of each profit center. This means that the department manager is judged not only on the amount of revenue he brings in, he is also judged on his ability to control departmental costs.
For example, current year revenues might have doubled from last year, but expenses might have tripled. In this case, the department is operating less efficiently than it could be. The department manager should focus on increasing revenues while maintaining the same cost levels.
Cost centers, on the other hand, can’t be definition have profits because they only consume recourses without actually contributing to the revenues of the company. A good example of a cost center is the accounting department. This is a necessary department that doesn’t generate revenues at all. It simply uses resources. Higher-level management tends to analyze the performance of a cost center by comparing the estimated budgeted numbers for the period with the actual results. If the center managers can achieve the budgeted numbers, they are considered efficient and effective managers.