Redefining your Profit Centers
In management accounting (as opposed to financial accounting), operations are broadly categorized as either cost centers or profit centers.
Basically a cost center includes all operations where significant investment is required but profits are minimal. Nonetheless, these operations are still considered critical to long term stability and continued profitability of the business. Profit centers on the other hand are operations from which significant profits are made. Although these operations require investment, their returns per dollar are usually reasonably high.
Both cost centers and profit centers are critical to business success.
In redefining your profit centers you first need to appreciate the significance of the two sides. While you may be tempted to create more profit centers and kill a few cost centers, you must first critically analyze the importance of individual operations to the business.
Operations such as customer service are simply invaluable and can only be bettered rather than done away with. For example, a customer support desk rarely earns direct profits for the business, does it? However, a great customer service desk will help with customer follow-up and technical assistance which can go a long way in improving customer satisfaction. When customers are satisfied they will keep doing business with you and by that you’ll gain increased profit.
Research and development as well as branding are two other areas that are categorized as cost centers but which are too important to tamper with.
Do not treat every department as a cost center.
One mistake most businesses make is to treat every department as a cost center. This is where managers of various departments are simply rewarded for cutting costs. What follows is that they fail to sufficiently reinvest in the business to strategically position operations for future profitability. Hence you end up with outdated facilities and equipment, and soon your customers as well as staff start looking elsewhere because you’re no longer satisfying their needs.
A profit center should blend current needs for cash with the desire to grow profitably in the future. And in doing that you can’t ignore factors such as return on capital, relative returns, efficient use of resources, and opportunity cost.