81198049 Profit Center Approach

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Management

Control

System

Group 5

Dheeraj Seth, 21

Dinshah Anklesvaria, 22

Divya Sanjiva, 23


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Fazalabbas Munni, 24

Gaurav Advani, 25


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Q) "Adopting profit centre approach may not be an appropriate solution

always". Do you agree? Give reasons for answer quoting various

situations in the business.

Ans: 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 centersor 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 inBusiness Solutions, the

data collection company Data Recognition, Inc. made the shift to a profit center-based system

and was pleased with the results. The profit centers allow 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 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 offsetthose 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. 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.

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 satisfied 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.
http://www.answers.com/topic/nbthttp://www.answers.com/topic/nbt


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In a business, every cost is supposed to have an ROI, and the cost is incurred only when the ROI

promises to be more than the investment itself.

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 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 itprovided services to outside companies.

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.

Considering that HR is a crucially important function but alas, is usually bogged down by routine

things like recruitment etc., and not in value-addition activities like training and development.When this change occurs, HR can be an indirect profit center through the following actions :

1. Savings through :

a. Negotiation during recruitment : Trying to get the best for the least ;

b. Training : For example healthcare training to save on health-related downtime and absentism /


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medical bills etc. ; reducing wastages through job-oriented hard skills training etc.

c. Reducing attrition, thereby cost of recruitment.

2. Raised productivity through value addition such as Hard Skills & Soft Skills training for

augmenting proper job-related skills, motivation, engagement and focus etc.

Thus If both the 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.

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81198049 Profit Center Approach