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6 Benefits of using cost center to increase your company profits

Many of you may not be familiar with the concept of cost center.  What is a cost center and why you need cost center in managing your business.  Cost center is one tool used in profit optimization and turnaround your company as it can help you increase profitability by increasing efficiency in the company’s operation. Creation of cost center is highly related to organization structure. Therefore, restructuring of your company organization structure, if any, is better done prior to creation of cost center.

What is a Cost Center? 

Cost center is a unit within a company that does not directly add to profit but still costs the company money to operate such as accounting, finance, HR, IT, Procurement function.  Cost centers only contribute to a company’s profitability indirectly from efficient operation.  The main use of a cost center is to track expenses for comparison to budget. 

The concept of cost center and profit center is the same, the different is in the function of the unit.  Cost center only amasses cost while profit center contributes to profitability directly through its actions.  For simplicity, I define all units within a company as a cost center for discussion purposes.

The unit leader of a cost center is responsible for keeping costs in line with budget.

To what smallest level a company would like to set up its cost centers?

It depends on what benefits the company can get from tracking the unit expenses.  As the smaller the unit of cost center, the more work it requires as there are more cost centers to monitor and control. 

Cost centers are only used internally and not used for external reporting. As the main purpose of a cost center is tracking expenses, what benefits do we get by doing so, so that the cost must outweigh the benefits. 

Benefits of a Cost Center

Imagine that your cost is only identified as Sales, General and Administrative expenses.  Who is responsible for this cost?  The CEO.  The CEO can not pass down the responsibility to manager as all cost is lumped together.  It is difficult to identify which units performance can be improved in its efficiency.  If you have a tool which can help you making your job a lot easier, wouldn’t you go for it?  Sure.

There are 6 benefits of using cost center to increase your company profits:

Benefit #1: Better monitoring and control

With the use of cost center, CEOs and Business Owner can monitor and control expenses,  all expenses are recorded and booked in a particular cost center so that CEOs know what is the cost of a particular unit and how resources is being used.

Benefit #2: Increase accountability, Budget vs Actual

By having all cost grouped in cost center and having the budget per cost center as well, the manager of the unit is more accountable as its performance is compared between budget and actual.  The manager needs to justify any variance between budget and actual. 

Benefit #3: Increase efficiency – Easier to pin point which will lead to increase profits

By having cost center, it’s easier for the upper management to pin point where efficiency can be increased. It helps management utilize resources in smarter ways by having a greater understanding of how they are being used.

Benefit #4: Easier trouble shooting

Having cost centers is a friend to profit optimization and company turnaround.  It’s much easier to trouble shooting as cost is grouped into responsibility area and each cost is detailed.

Benefit #5: Easier to measure performance

Having a cost center help to measure performance as the KPI is clear to each cost center unit and the planning is done in more orderly and in detail.

Benefit #6: Easier to manage:  pass on responsibility and accountability to the lower level

The CEOs can pass down the accountability and responsibility to the lower level with measurable performance.  It’s all reflected in the cost center performance, KPIs easily set up and budget and actual are tracked.  Accountability is established.

Case Study

In one of the company I worked for, the company had cost centers but it was not sharp enough.  The company had 2 business units but the revenue and cost were not matched for each business units but lumped together.  Trouble shooting where the problem is very difficult as I could not pin point which business was not doing well.  I needed data to be able to analyze the problems and found the solution.  Therefore,  I created cost centers which clearly classified the cost and matching the revenue and cost of each cost centers.  After the problem was identified, I further created profit and cost centers for each plant to enable me analyze and evaluate the cost structure of each plant and its profitability.  I was successfully turnaround the company by about USD29mio in one year.  Benefit of Cost Centers is tremendous and it’s one of the tool which can be used to increase profits massively.  

SUMMARY

Cost center is a tool used to track expenses to increase operation efficiency, thus, increasing profits.  Cost center is only used internally.

6 Benefits of using cost centers are:

Benefit #1: Better monitoring and control

Benefit #2: Increase accountability, Budget vs Actual

Benefit #3: Increase efficiency

Benefit #4: Easier trouble shooting

Benefit #5: Easier to measure performance

Benefit #6: Easier to manage

CEOs can focus on the big picture and working to achieve its vision and increase profitability using the tool, cost center, to manage the business.

Cost Center FAQ

What is a Cost Center?

Cost center is a unit within a company that does not directly add to profit but still costs the company money to operate such as accounting, finance, HR, IT, Procurement function.  Cost centers only contribute to a company’s profitability indirectly from efficient operation.  The main use of a cost center is to track expenses for comparison to budget. 

To what smallest level a company would like to set up its cost centers?

It depends on what benefits the company can get from tracking the unit expenses.  As the smaller the unit of cost center, the more work it requires as there are more cost centers to monitor and control. 

What are the benefits of using cost center to increase your company profits?

Benefit #1: Better monitoring and control
Benefit #2: Increase accountability, Budget vs Actual
Benefit #3: Increase efficiency
Benefit #4: Easier trouble shooting
Benefit #5: Easier to measure performance
Benefit #6: Easier to manage