How to use profit centers
Profit Centers Defined
Establishing a profit center is nothing more than giving it a name and have a software program that you can use to track income and expense associated with it. For example, many companies will treat a certain product line as a profit center so they are determine if the resources required to support the product line is appropriate with it’s revenue stream.
Tracking Income and Expense
Strong accounting software programs allow you to setup departments within specific Income and Expense accounts. This allows for financial reporting of overall company performance while still preserving departmental details about each profit center. In this scenario a profit center is setup as a separate department in the General Ledger software module. Direct income from sales and direct costs from purchases is allocated to these departments during normal business activity like invoice processing in Accounts Receivable and Accounts payable programs. The choice to see profit center detail is usually shown as a option when running financial reports.
Another important part is to properly allocate overhead to each department. Although overhead is not directly related to each profit center it still needs to be part of the equation since overhead also changes in order to support all of the profit centers. But how do you know how much of overhead costs to apply to each profit center? You may think it would be divided up equally but that would give a false allocation. Instead you want to take a weighted percentage of the direct costs of each department. To calculate the percentage take the direct cost of each profit center and divide it by the direct costs of all profit centers. This way the profit centers with less activity will bear a smaller amount of the overhead. Profit centers with a lot of activity will bear more of the overhead.