MANAGEMENT CONTROL

SYSTEM

PROFIT CENTERS
 PROFIT CENTERS
 Profit Centers
Inputs are related
to outputs

Inputs Outputs
(dollar cost) Work (dollar profit)

Business
Unit
 PROFIT CENTER
 Profit Centers are responsibility centers whose managers are held
accountable for profit, which is a measure of the difference between
the revenues generated and the costs of generating those revenues.

 In deciding responsibility center as profit center is whether the

manager has significant influence over both revenues and costs.

 Many firms refer to their investment centers as profit centers, but

there is a conceptual distinction, profit center managers are held
accountable for profit but not for the investments made to generate
them.
 PROFIT CENTERS
 Conditions for delegating Profit Responsibility
 The manager should have access to the relevant information
needed for making a decision,
 There should be some way to measure the effectiveness of the
trade offs the manager has made.

 Advantages of Profit Centers

 The quality of decisions may improve – closest to the point of
decision ,
 The speed of operating decisions may be increased,
 Headquarters management relieved of day to day decision
making,
 Managers are freer to use their imagination and initiative,
 PROFIT CENTERS
 Provide an excellent training ground for general management,
 Profit consciousness,
 Profit centers provide top management with ready made information on the
profitability of the company’s individual component,
 Profit centers are particularly responsive to improve their competitive
performance.

 Difficulties with Profit Centers

 Decentralized decision making will force top management rely more on
management control reports than on personal knowledge of an operation
(loss control),
 The quality of decisions made at the unit level may be reduced
 PROFIT CENTERS
 Friction may increase because of arguments over :
 the appropriate transfer price,
 the assignment of common costs, and
 the credit for revenue that were formerly generated jointly by two or more
business units working together,
 Functional units may now be in competition with one another.
 Divisionalization may impose additional cost.
 Competent general managers may not exist in a functional organization ,
 Too much emphasis on short-run profitability.
 BUSINESS UNIT

 Business Unit as profit center since managers in charge of such unit

typically control product development, manufacturing, and
marketing.
 Constraints on Business Unit Authority
 The Business Unit manager would have to be autonomous as the president of
an independent company, but practically such autonomy is not feasible .
 The effectiveness of a business unit organization is largely dependent on how
well these trade-off are made between business unit and corporate constraints.
 Constraints from other business unit (dealt with another) related to product
design, marketing decision and sourcing decision.
 BUSINESS UNIT

 Constraints from Corporate Management

 New investment , business unit must compete with one another for a share of the
available funds.
 Companies impose some constraints on business units because of the necessity for
uniformity ( e.g corporate accounting and management control system, uniform
policies such as vendor selection, computer equipment, even the design of the business
letterhead )
 OTHER PROFIT CENTERS
 Functional Units
 Functional units e.g marketing, manufacturing and service operations -
as profit centers.
 No guiding principle declaring that certain types of units are inherently profit centers
and others are not,
 A unit should be a profit center is based on the amount of influence the unit’s manager
exercise over the activities that affect the bottom line.
 Marketing
 A marketing activity can be turned into a profit center by charging it with the cost of the
products sold.
 Generally marketing activities as revenue centers rather than as a profit centers.
 OTHER PROFIT CENTERS
 Manufacturing
 The manufacturing activity usually an expense center.
 Service and Support Units
 Units for maintenance, IT, transportation, engineering, consulting , customer service,
and similar support activities can all be made into profit center.
 Other Organizations
 A Company with branch operations that are responsible for marketing in a particular
area is often a natural for a profit center.
MEASURING PROFITABILITY

how well the

Management
performance manager is doing
( ( day to day )

Types of
profitability
measurement
how well the
Economic
profit centers
performance
is doing as an
economic entity
MEASURING PROFITABILITY

 Contribution margin

Types of  Direct profit

Profitability  Controllable profit

Measures
 Income before tax

 Net income
 Profit Center
Income Statement
Revenue $ 1,000 Profitability Measure
Cost of sales 600
Variable expense 180
---------
Contribution margin 220 (1)
Fixed expense incurred in
the profit center 90
----------
Direct profit 130 (2)
Controllable corporate charge 10
----------
Controllable profit 120 (3)
Other corporate allocation 20
----------
Income before tax 100 (4)
Taxes 40
----------
Net income $ 60 (5)
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