Profit Centres

Profit Centres • Business units are created to delegate more authority to operating managers. • The degree of delegation may differs • Complete authority for generating profits is never delegated to a single segment of the business

…contd • To create a profit centre: • Manager needs relevant inputs for decision making • There must be effective ways of measuring his performance • It would be interesting to note that the measures need not be financial alone- can you identify a few non financial measures?

Advantages of profit centres • Quality of decisions • Speed • Management by exception through effective decentralisation • Better information systems in place • Initiative • Innovation

Disadvantages • • • • •

Loss of control Loss of focus? Short run goals? Quality of decisions Generalist outlook for the specialist

Requirements of a profit centre • Control on costs • Control on revenues

Constraints in a profit centre • On authority • Constraints from business units • Top management

Who can be profit centres? • Can support facilities or cost centres be converted to or assessed as profit centres? • Eg. Finance, Purchase, Legal…

Profit Centre Income Stmt Revenue Less: COGS Variable costs Contribution Margin Fixed expenses incurred in the profit centre Direct Profit Controllable Corporate Charges Controllable Profit Other Corporate Allocations Income Before Taxes Less Taxes Income after taxes

Measuring Profitability • Contribution margin- Spread between revenue and variable expenses • Is the profit center head effective if he maximises contribution? • Fixed expenses- Should they be considered? • Can profit centre heads control them?

• Direct profit- Incorporates expenses directly or traceable to profit centre • Traceable costs are charged regardless of whether they are controllable or uncontrollable

• Controllable profit- The portion of headquarter costs is charged to the profit centre • Income before taxes • Net Income- In come after taxes • Sometimes profit centers may operate in tax haven zones.. Which of the above is the most appropriate measure? Why