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Profit Centre



RAISA RAHMA 1210534012




A Profit Centre is a segment of a business, often called division that is responsible for both
revenue and expenses. In a non-profit organization, the term `revenue centre' may be used
instead of profit centre' as profit may not be the primary objective-of such an organization. In
other words, a profit centre is a responsibility centre in which inputs are measured in terms of
expenses and outputs are measured in terms of revenues.

In a profit centre, manager has the responsibility air' authority to make decisions that
affect both costs and revenues for the department or division. In fact, the main objective of a
profit centre is to earn profit. Thus, a profit centre manager aims at both the production and
marketing of a product. Such a manager decides about the production policies, the price and
marketing strategies. He is concerned with increasing the centre's revenues by increasing
production and/or improving distribution methods. However, such a manager does not take
decision or has control over the investment in the centre's assets. He may make proposals for the
investment in the division but the decisions about it are normally taken by the top management.

Financial performance of a profit centre manager is measured in terms of achievement of
budgeted profits that way, a comparison has to be done between the profit centre and budgeted
profit. However, a problem arises in measuring its performance in terms of profits, when
products and services are provided to another unit within the organization. Determination of
profit is easier when products and services are sold outside the organizations.

In most of the organizations, it is found that there is more concentration on profit centre
as an important unit for the purpose of control. In case of profit centre, it is possible to have an
effective system of evaluation of performance which is quite necessary to impose effective
control. Such effective control, from this point, is not possible neither in case of expense centre
nor revenue centre.
The profit centre focuses its attention on the most crucial element of an organization. The
profit is a combined measure of both effectiveness and efficiency. It provides a powerful tool for
measuring how well the profit centre and its manager has performed.

Advantages of Profit Centres
The operating decisions can be taken quickly without refering to the headquarters.
Quality of the decisions is improved because the managers taking these decisions are aware of
the ground realities and also closest to the point of decision.
Higher management can focus on macro issues leaving the micro issues to be tackled by
operational managers.
Profit consciousness is enhanced in profit centre managers due to the fact that profit is going to
be the criteria for assesment and as a result the managers would be sensitive to the impact of
their action on both the expenses and revenue.
Managers are free of micro restraints and can use their creativity and initiative.
Profit centres are incubators for future business managers at higher level as they are excellent
training ground for general management.
Profit centres creates a reservior of managerial talent which a company can use during
Use of profit centres helps the company to locate and diagnose the problem areas quite easily,
because profit centres provide information on the profitability of the components of the

Difficulties with Profit Centres
Top management may loose some control as the control reports prepared by the profit centres
are not as effective as personal knowledge of an operation.
Managers may be lacking competence in general management operations.
There may be unhealthy competition among the various profit centres, which may manifest
itself in form of undesirable behaviour of managers. These type of undesirable behaviour may
include, hiding of information, hoarding of equipment etc.
There may be disagreement among different profit centres regarding transfer, price, sharing of
common cost, sharing of revenues generated by joint efforts.
Profit centre managers may lay emphasis on short term profits at the expense of long term
profits by neglecting crucial area like manpower training and development, maintenance and
research and development activities.
High profits of the profit centre may not always optimize the profits of the company.
Setting up of profit centres may entail extra cost to the company in the form of additional
management, staff and record keeping and additional ancillary infrastructure which may lead to
redundant tasks at each profit centre.

In companies where each of the principal function of manufacturing and marketing is
performed by seperate organizational units, these type of compnies (organizations) are known as
functional organizations. As the companies expand and mature over a period of time offering
diverse products and services, it becomes difficult for top management to pay equal attention to
all products and services. In this scenario one of the option available is to divisionalize the
company which implies that each major organizational unit in the company is responsible for
both the manufacturing and the marketing of the product, implication of this move is that there is
greater amount of delegation of authority and responsibility to the operating managers.

The design of profit centres in organizations will have to contend with the question of
service functions centrally located in the headquarter which do not directly contribute towards
performance of
profit centres. We also have to consider the domain of the profit centre. Thus, defining the
boundary conditions for the profit centres is an important aspect of the design of profit centres.
The major problem associated with the service functions is that there is no direct
measures of profit which can satisfactorily evaluate the performance of the function.
Even though the service functions are very important in the profit performance of the company
as a whole, it is very difficult to isolate and measure their contribution. It may be possible to
organize many service centres into profit centres and their services could be sold, but in most
organizations they are intended to provide their services only to the organization. Their services
may not be used in sufficiently large volume if they are organized as profit centres. The
examples of service functions are management information service, legal services, corporate
planning department etc.
A plausible solution is to distribute the cost of service functions among various profit
centre where such activity can be economically justified.
The major problem is to define the boundary conditions for the profit centre where by we can
balance the costs and revenues of the division. The major objective of the exercise is to ensure
that we maximize certain revenues and minimize certain costs.
Therefore, measurement of profits as the outcome becomes the major criteria in decision making
within the division. This leads us to the most logical choice of accepting profit performance
measurement as the major factor guiding the determination of profit boundaries.

Having demarcated the boundaries for profit centres; it becomes important and necessary to
measure their performance. However, with boundaries so set, performance measurement
becomes easier and convenient. But still the measurement of profit is not a simple task. It poses
problem as the concept of profit may not be very clear, the problem of transfer pricing has to be
tackled and the decision has to be taken regarding compensation based on evaluation.
Basic of Measurement of Performance
It is not quite easy or simple to decide the basis of measurement of performance. However, the
profit contribution by the profit centre may be taken as basis for it. However, if current profit is
taken as the basis it may be in tune with goals of the organization which may be short-term as
well as long-term. In fact, the short term profit goals may be in consonance with the long-term
profit goals.
In this connection, one problem arises regarding question of current profitability as compared to
future growth. If we confine to current profit only, it would be at the cost of future growth.'
Similarly, the concern for future growth can be achieved at the expense of the current profit
Another problem may arise when we devote our attention to R&D. Any additional cost incurrent
for R&D would certainty affect the current profit performance. Similarly, the cost for current
training and development which is quite necessary for the development of the organization
ultimately has the adverse impact on current profit performance.
The Concept of Profit
There are different concepts used related to profit, hence, that would also pose a problem in this
connection. This term may have different connotations, such as book profit, real profit, and profit
contribution. The easiest and most acceptable concept of profit is the book profit, which is shown
by the books of account. However, when we take into account the book profit, the problem of
allocation of organizational expenses arises. It is not easy to solve it as no method of such
allocation seems to be scientific one and that may be questionable.
The real profit may be a better basis of evaluation of performance, as the real profit takes into
account economic value of the resources consumed. For this, valuation of resources consumed
should be taken, taking into account depreciation. In this case, also the question of allocation of
common expenses remains untackled.

The behaviour of the divisional managers is often heavily influence by how their
performance is measured. Thus, profit centres act as a tool for motivating such managers.
The different arguments supporting the value of profit centre as motivational tool can be
summarized as follows:
1) A profit centre manager is perceived to have a higher status in the organization and hence
provides a psychological benefit to the division manager. It is argued that this perceived
importance motivates him to perform better. By making the managers responsible for the profit
performance of their divisions it tried to blend their objectives with the profit objectives of the
2) Profit centers tend to enhance the profit consciousness of the managers and subordinates
within the division and hence they all strive for maximizing the profits of the division. This leads
them to become conscious about the expenses in the division. They constantly try to evaluate
every expense decision in the context of its relationship to profits.
3) The position of being a profit centre, manager in an organization brings in a sense of pride and
belongingness, which in psychological terms provides sustenance for the needs of self
actualisation and self-esteem. Most of the organization theorists argue on these lines.
4) The freedom and authority given managers imbibe a sense of independence and responsibility
in the profit centre managers enabling them to strive for better performance.
All these arguments are essential or inter-related and may at least partially contribute
towards better performance when combined with a realistic system of rewards and punishments.

Profit centres aim to focus attention of the managers on control by making them
responsible for both' revenues and expenses of the centres. Establishing and operating control
system based on profit centres poses many practical difficulties such as deciding on the basis of
profit measurement, allocation of expenses, and inter-divisional transfer prices.
A major problem to be confronted in establishing profit centres is the very question of the
boundaries of the profit centres within the organization. Profit centres may be an important
motivational tool in organizations. There is evidence to show that they imbibe a sense of profit
consciousness among division managers.
The establishment of profit centres and the evaluation of performance using profit
measures s pose several ticklish questions arising from combined influence of a host of factors.
Profit centres, in order to be effective and enduring in an organization, would also require a
performance related compensation system which may again pose several practical difficulties in
the implementation of the idea.