A profit center is a part of a corporation that directly adds to its profit.

[edit] Overview
A profit center is a section of a company treated as a separate business. Thus profits or losses
for a profit center are calculated separately
A profit center manager is held accountable for both revenues, and costs (expenses), and
therefore, profits. What this means in terms of managerial responsibilities is that the manager
has to drive the sales revenue generating activities which leads to cash inflows and at the
same time control the cost (cash outflows) causing activities. This makes the profit center
management more challenging than cost centre management. Profit center management is
equivalent to running an independent business because a profit center business unit or
department is treated as a distinct entity enabling revenues and expenses to be determined and
its profitability to be measured.
Business organizations may be organized in terms of profit centers where the profit center's
revenues and expenses are held separate from the main company's in order to determine their
profitability. Usually different profit centers are separated for accounting purposes so that the
management can follow how much profit each center makes and compare their relative
efficiency and profit. Examples of typical profit centers are a store, a sales organization and a
consulting organization whose profitability can be measured.
Peter Drucker originally coined the term profit center around 1945. He later recanted, calling
it "One of the biggest mistakes I have made." He later asserted that there are only cost centers
within a business, and “The only profit center is a customer whose cheque hasn’t bounced.”[1]

Profit Center
A Basic Understanding of the Business Term Profit Center
By Joshua Kennon, About.com Guide
In the business world, a profit center is an area of a company that adds directly to its bottom
line profit. Like with all areas of life following the 80/20 rule, also known as Pereto’s Law,
most of a company’s profits are likely to come from only a handful of operations, products,
or divisions. Microsoft has thousands of products, but the major profit centers are the
Windows operating system and the Microsoft Office software. Each profit center provided
the stream of funds for the company to use when it expanded into other fields such as video
games with the X-Box as well as fund large share repurchases and cash dividends.
A manager or executive in charge of a profit center is likely to face a much more difficult job
than someone overseeing a division that is not classified as a profit center. The reason is
simple. A profit center manager is going to have to both increase sales by generating
additional revenue and decreasing costs (as a percentage of revenue), much like an
entrepreneur would have to do in his or her own independent business.
A cost center manager, on the other hand, only has to worry about staying within budget. (A
cost center is a department that is important to the overall success of a company but its
contribution to revenues and profits can be only incrementally measured. A cost center is an
area that typically runs red ink in upfront losses but will result in a much richer company if
managed correctly; think the research division of a major pharmaceutical corporation that
spends billions developing new drug treatments without selling a single pill for years.
Clearly, if the pipeline were to dry up and the cost center shut down, the company would
soon find itself a shadow of its former self. Yet, it is a cost center and not a profit center that
is likely to find itself at the top of a list when it comes to recessionary layoffs.)
Many businesses are tempted to treat all divisions as cost centers instead of profit centers.
This can be a horrible mistake because if managers are rewarded simply on cutting costs, they
will not make sufficient reinvestment in a business to grow profitably for the future. Hence,
you eventually end up with outdated equipment, facilities, and staff and your customers are
likely to go elsewhere because their needs aren’t being met. A profit center approach, on the
other hand, blends the need for current cash with the desire to grow earnings in the future,
making a manager accountable for the long-term health of a business.
A closely related concept to a profit center is an investment center. Whereas a profit center
measures simply the overall contribution of a division’s profitability to the parent
corporation, an investment center measures all uses of capital against a theoretical required
rate of return. Although the investment center approach is extremely useful in evaluating the
overall profitability of a company as measured by return on capital deployed, it can be
manipulated by managers who know how accounting rules work. By simply modifying
depreciation rates, for instance, they could increase the estimated return on invested capital.
They could also change the so-called hurdle rate to a more easily attainable figure (the hurdle
rate is a return a profit center or other division must earn in order to be considered a good
investment for the company; in other words, it is a minimum acceptable rate of return).
The legendary management consultant and thinker Peter Drucker originally created the term
profit center in the 1940’s. He subsequently asserted that the term profit center is a misnomer
that leads managers to focus on the wrong overall priorities, insisting instead that everything
is a cost center. By focusing only on the absolute profit of a division, factors such as return on
capital, opportunity cost, efficient use of resources, and relative returns are ignored to the
detriment of the stockholder or owner.
Kamus baron

Responsibility unit that measures the performance of a division, product line, geographic
area, or other measurable unit. Divisional profit figures are best obtained by subtracting from
revenue only the costs the division manager can control (direct division costs) and
eliminating allocated costs common to all divisions (e.g., an allocated share of company
image advertising that benefits all divisions but is not controlled by division managers). Profit
is a very often used method to evaluate a division's financial success as well as the
performance of its manager. In determining divisional profit, a Transfer Price may have to be
derived. The divisional profit center allows for decentralization. As each division is treated as
a separate business entity with responsibility for making its own profit

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Ensiklopedia gale: small business

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 centers or 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
in Business Solutions, the data collection company Data Recognition, Inc. made the shift to a
profit center-based system and was pleased with the results. "We saw the importance of
evaluating, individually, areas of our business that are distinctly different," said Steve Terry,
the company's vice president of systems. "The profit centers have allowed us 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 centers (although, if it is a
single-person company, that company would really have profit and cost activities, since all
business "units" are the same person). 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 offset those 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. Examples of profit
centers would be the manufacturing units that produce products for sale to consumers or other
businesses. The sale of those products generates a profit that offsets the expense of creating
the products.
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.
Turning a Cost Center Into a Profit Center
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 complacent 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. The company's
other business units are then required to pay for the services they used to get for free. But in
return, they are allowed to go outside the company and contract with another firm to provide
those services. Likewise, the former cost center may be allowed to sell its services to other
companies. The expectation is that this free market system will improve performance through
increased competition while increasing profits by turning former cost centers into profit
centers.
"When a business firm becomes a corporate community of entrepreneurs who buy, sell, and
launch new products and services internally as well as externally, it gains the same creative
interplay that makes market economies so advantageous," said management professor
William E. Halal when discussing making the move to profit center-based operations in USA
Today Magazine.
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 profit earned for the services would exceed the cost of providing the services. While all
the money in this transaction would stay within the company, thus making it seem to be a
meaningless way of creating a profit for the IT department, it is done for two reasons. One is
to ensure that the IT department remains competitive with outside vendors providing the
same services, and the other is to ensure that the company's other business units do not waste
money on needless IT expenditures. Paying competitive market rates prevents the operating
units from wasting money, thus making them more competitive.
If the IT department is turned into that type of profit center, it is considered to be a "zero
profit center." In that situation, the department is expected to compete with outside vendors
for the company's information technology budget. If a division of the company selects the IT
department as its technology provider, it has done so because it feels it cannot purchase the
same quality services for a lower price from an outside vendor. It will not actually "pay" the
IT department for its services, but it will be charged by the IT department for services
rendered, and those charges will be subtracted from the division's budget. Thus, the IT
department does not really take in any revenue, but neither does it cost the company any
money because the division that utilized its services would have had to spend money to hire
an outside vendor. This, then, creates a zero profit center. Such a business model forces the
IT department to be more competitive in its pricing and to provide high quality work if it
hopes to survive as an operating unit.
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 it provided services to outside companies. This method of operation has become
far more common in the 1990s and beyond, as companies seek new revenue streams that have
low start-up costs.
If the IT 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. 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.
Profit Centers and Their Changing Role in Industry
In large companies, especially manufacturing companies, it has become a fairly common
occurrence to break the company into small pieces, with each piece operating as a profit
center that has to compete for business. In this manner, a large business can suddenly find
itself operating as a small business. For example, say the Acme Company produces a finished
product that is composed of five smaller parts. Instead of operating as one large company that
produces all five parts needed for the finished product, Acme has decided to split into six
separate units—one that assembles and sells the finished product, and five smaller companies
that each produce one of the parts needed for the finished product. Beyond Acme, there are
other companies that produce those same five parts needed to produce the finished product.
Each of the five part manufacturers is now operating as a separate profit center, reporting to
Acme's corporate office. Each has to determine its own methods of operation, and each has to
determine how it is going to show a profit. There may be internal agreements in place that
mandate that each of the five units will continue to work together to produce the finished
product, or Acme may throw things wide open by stating that there is no corporate mandate
forcing the five divisions to continue to work together.
If the latter model is chosen, the corporation may have decided that, while the company could
continue making steady—but small—profits if it kept using the five units together as it had
for decades, there was a chance that the company could make huge profits if it made each of
the five units accountable for its own bottom line and opened up the manufacturing process to
both internal and external competition. In such a radical environment, it was conceivable that
one of the five units could go bankrupt and cost the company money, but senior management
believed that the hugely increased profits in the other four units, and the resulting higher
profit margin realized by the sale of the finished product, would more than offset the loss of
one unit.
Thus, each of Acme's five units, formerly divisions within the larger company that were not
accountable for directly generating profits, were now separate entities that had to show a
profit to continue operating. Each of the units had gone from a cost center mentality—buying
materials to produce part of a product that showed up on the company's overall bottom line—
to a profit center mentality, responsible for showing a profit based solely on the production
and sale of its one part. As part of the shift to becoming a profit center, each of the five units
would also be free to sell its part on the open marketplace. Acme might make that freedom a
restricted one that prevented sales to a direct competitor, or it might take the full plunge and
make the unit a fully stand-alone company that was free to sell its part to any other company
in the market, including direct competitors. That decision would dictate whether Acme's
move was a small one, designed to encourage each of its five units to think creatively and
work harder to perform at a high level, or a large one, designed to change the very core of the
company's business in a bid for higher profits.
Profit Centers and Small Businesses
When operating a small business, it may not be practical to use the profit center concept
initially because the business is so small. Fewer employees mean fewer business units, which
means fewer opportunities to create profit centers. In addition, in a small business, the
president or the chief financial officer is probably monitoring financial results very closely,
which means that he or she knows exactly where profits and losses are occurring. However,
as a small business begins to grow, establishing profit centers often makes sense. Data
Recognition, Inc. found that switching to profit centers made sense as the company increased
in size. "Establishing profit centers, and generating daily profit/loss statements, has allowed
us to better identify, and correct, our weaknesses," said vice president Steve Terry.
Even without adopting the profit center accounting concept, the idea of profit centers has
value for small businesses in that they should always be looking for new ways to generate
revenue. When operating a small business, there are essentially two ways to create a new
profit center. The first method is to create an extension of the original business—a new
product related to existing products, or new services that build on services that are already
offered. The second method is to create an entirely new business altogether that can operate
using the first business's corporate infrastructure (at least initially) and that can be operated at
the same time as the original business.
The rapid spread of the World Wide Web has created an unprecedented method for creating
new profit centers. Almost every company today has a Web site to dispense public relations
information and to make it easier for customers to contact the company, but more and more
firms are recognizing that there is money to be made on the Web. Most corporate Web sites
begin life as a cost center, since they are initially just used to disseminate information, but
most can be transformed into a profit center.
When seeking new profit centers, small business entrepreneurs should avoid business models
that have regularly failed on the Web. These include setting up an entertainment site that
attempts to charge a fee for that entertainment; relying on advertising as a revenue stream, as
banner advertisements are proving to be quite unsuccessful in bringing in new customers;
charging subscription or other visitor fees; and biting off more than you can handle by
attempting to establish business-to-business sales that may not be achievable.
Further Reading:
Auer, Joe. "IT as Profit Center? It Can Be Done." Computerworld. May 1, 2000.
Bickerstaffe, G. "The Perils of Being a Profit Centre." International Management. October
1982.
Coburn, Jeff, and Michael Preston. "Profit Center Management: The Wave of the Future?"
Legal Management. July-August 1997.
Greco, Susan. "Are We Making Money Yet?" Inc. July 1996.
Feldman, Joan M. "Divide and Prosper." Air Transport World. May 1995.
Hoffman, Thomas. "Profit Centers vs. Cost Centers. Computerworld. August 2, 1999.
"Internal Competition Makes Firms Stronger." USA Today Magazine. December 1994.
O'Sullivan, Orla. "On-Line Markets Can Turn Web Site from Cost Center to Profit Center."
American Banker. April 4, 2000.
Pronko, Nick. "Managing Your Business with Profit Centers." Business Solutions. January
1998.
Turner, Mary and Gavin Welbourn. "Turn a Cost Center into a Profit Center."
Communications News. October 1, 1998.
Walker, Gordon and Laura Poppo. "Profit Centers, Single-Source Suppliers, and Transaction
Costs." Administrative Science Quarterly. March 1991.

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