This document discusses profit centers and how to evaluate their performance. A profit center is a responsibility center whose manager controls both revenues and costs. To delegate decisions to managers, they must have relevant information and a way to measure effectiveness. Business units are often set up as profit centers. Functional units like marketing, manufacturing, and services can also be profit centers. Performance is measured using various profitability metrics like contribution margin, direct profit, and net income.

1. Profit centers
Chapter 5

2. Profit Centers
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What is a profit center?
It is a responsibility center whose manager
and other employees control both the
revenues and the costs of the product or
service they sell or deliver.
When a responsibility center's financial
performance is measured in terms of profit
centre is called profit centre.

3. Conditions for delegating profit
responsibility
To delegate a trade-off decision to a lower level
manager, two conditions should exist. Which
are as follows:
The manager should have access to relevant information
needed for making such a decision.
 There should be some way to measure the effectiveness of
the trade-offs the manager has made.
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4. Advantages of Profit Center
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Quality of decisions may improve
Speed of operating decisions may be increased
Relieved of day to day decision –making
Profit consciousness
Pressure to improve their competitive performance
An excellent training ground for general management
Managers are free to use their imagination and initiative

5. Disadvantages of Profit Center
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It will force top management to rely on management
control reports rather than personal knowledge
entailing some Loss of control
Organization units may be in competition with one
another
Divisionalisation may impose additional cost
Competent manager may not exist
Too much emphasis on short term profitability at the
cost of long run profit
No surety that individual profit center will optimize
the profit of whole organization

6. Business units as Profit Centers
Most business units are created as profit centers
since managers in charge of such units typically
control product development, manufacturing
and marketing resources.

7. Constraints on Business Unit
Authority
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Constraints on Business Unit Authority
 The Business Unit manager would have to be as autonomous
as president of an independent company. Practically such
autonomy is not feasible
Constraints from other business units
It is useful to think of managing a profit center in terms of control
over three types of decisions:
1. The product design
2. The marketing decision
3. The procurement or sourcing decision
Constraints from corporate management

8. Functional units as Profit Center
Multi-business companies are typically divided
into business units, each of which is treated as
an independent profit generating units. The
functional units which can be converted into
profit centre are as follows:
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Marketing
Manufacturing
Service operations

9. Contd…..
 Marketing
Marketing activity can be turned into profit center by
charging it with the cost of the products sold.
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Manufacturing
A manufacturing activity can be turned into a profit
center by crediting it for the selling price of the
products minus estimated marketing expenses.

10. Contd….
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Service and support units
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Units for maintenance, information Technology,
transportation,
engineering,
consulting,
customer service, and similar support activities
can be made into profit centers.

11. Measuring profitability
There are two types of profitability
measurements used in evaluating a profit
centre. They are:
 management performance
 Economic performance

12. Types of Profitability Measures
The performance of profit center manager, is
evaluated by five different measures of
profitability:
1)
2)
3)
4)
5)
Contribution margin
Direct profit
Controllable profit
Income before income taxes
Net income

13. Proforma of a Profit Centre income
statement
Revenue
xxxx
(-)Variable expenses
xxx
Contribution margin
xxx
(-)fixed expenses
xx
Direct profit
xxx
(-)controllable charges
xx
Controllable profit
xxx
(-)other corporate allocations
xx
Income before taxes
xxx
(-) taxes
xx
Net income
xx

14. Contd……
Contribution Margin
Contribution margin reflects the spread
between revenue and variable expenses.
 Direct profit
This measure reflects a profit center’s
contribution to the general overhead and
profit of the corporation
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15. Contd….
Controllable profit
It includes expenses that are controllable at
least to a degree, by the business unit
manager.
 Income before taxes
In this measure, all corporate overhead is
allocated to profit centers based on the relative
amount of expense each profit centre incurs.
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16. Contd…..
Net income
Net income is arrived after the tax is deducted
from income before tax.
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