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Why have cost and profit centres?

Cost and profit centres have three main purposes:

  • Financial accounting. They enable a firm to see how it is performing in comparison with budgeted figures.
  • Motivational. By giving staff targets, and also delegating authority, they are motivated to do well. Departments and smaller teams tend to be more effective than larger business groupings. They may be rewarded for good performance, and helped to avoid poor results. Responsibility must be linked to the necessary authority.
  • Organisational. By breaking the firm down into manageable chunks, senior management can monitor performance and identify strong and weak areas in the organisation. As a result it can focus production on particular units. Management time can then be concentrated on the areas where it is required and not wasted where it is not.

If a firm is broken down into cost and profit centres with agreed budgets, and carefully monitored using tools such as variance analysis, the firm possesses a powerful controlling mechanism. Used constructively, senior management have the means to identify high performing parts of the business and those which needs attention. It also provides a means of measuring and assessing staff and rewarding them accordingly.

Effective use of cost centres means that no part of an organisation will be hidden or unaccountable. All overhead departments, or STAFF FUNCTIONS, are clearly recorded and accounted for. Once this is revealed it is often possible to make considerable savings, and thus increase profits.

How the system is used will depend on the style of management adopted by the firm. This is another link to the human resource function and motivation. Business really is an integrated subject!

However, there are potential problems and issues associated with operating cost and profit centres:

  • The allocation of costs, particularly overhead costs, is problematic. The method chosen for allocation will affect the level of costs apportioned and so influence apparent efficiency and profit levels.
  • The performance of cost and profit centres can be influenced by external factors outside of the control of the managers running them, such as rising raw material and energy prices.
  • They may encourage competition and conflict, especially where remuneration is affected by performance and profit levels.
  • The pressure on cost and profit centres to cut costs may exclude consideration of ethical issues and result in organisations that perform well in terms of financial measures, but which fail to meet CSR targets.