"Profit center" and "cost center" are management
accounting (as opposed to financial accounting) terms. They identify
how the various parts of your business contribute to the operation
as a whole.
In Quicken and QuickBooks, profit centers and cost centers are
represented by the Class list.
The reason to track income and expenses for particular Classes is
to gather information on the profitability of various parts of your
operation.
A common term for a profit center is an "enterprise";
hence the frequent mention of "enterprise accounting" in
management accounting discussions--as in farm management accounting,
accounting for medical practices, and a wide range of other business
types.
Profit Center
A profit center is an area of your business that you operate
with the goal of earning a profit. A profit center also has a
well defined output. For instance, "corn" is typically a
profit center. If you raise corn you do so with the goal of earning
a profit, and the output is easily defined as bushels of corn.
Now, you could identify "crops" as a profit center.
That would be OK, but wouldn't provide very detailed management
information, partly because the output of "crops" can't be
easily defined except in terms of dollars--there's no single common
unit of measure across all crops.
Often you may need to break a single "chain" of
production down into two or more profit centers to gather figures on
which parts of your operation are profitable.
For instance, suppose you raise your own beef calves and market
them after a backgrounding period. To know whether you're efficient
at producing weaned calves and at backgrounding cattle, you
really need to set up two profit centers. You might call the first
Beef Cow/Calf and the second Cattle Backgrounding.
After weaning calves you would "sell" production from
the Beef Cow/Calf enterprise to the Cattle Backgrounding enterprise,
at a fair market price. (Transferring income and expenses between
Classes will be discussed in another article.) This credits the Beef
Cow/Calf enterprise with income, and charges the Backgrounding
enterprise with expense. If you've kept a good record of other
income and expenses for the two enterprises, at year's end you'll be
able to determine whether both are profitable parts of the farm
business.
Cost Center
A cost center is an area of your business that you primarily
operate to service the needs of one or more profit centers. A
typical example of a cost center may be a combine. Unless you do a
lot of custom harvesting you don't operate a combine to earn a
profit; but rather, to supply harvesting services to corn, soybeans,
wheat, or other profit centers.
The main reason for identifying cost centers in your operation is
to figure out how much those services are costing. In the case of a
combine, this information can help you make decisions about repair
or replacement..."How much did I spend on combine repairs last
year?"...or whether you should be hiring custom harvesting
instead of owning the machinery yourself. (Our ManagePLUS
add-on for QuickBooks would also show you combine repair costs per
acre or per hour.) Also, when you prepare profit and loss statements
for any profit centers, you may allocate charges from any cost
centers to them.
Generally speaking, you should identify no more than a few
important cost centers in your operation. Otherwise accounting for
them will become a burden.
Profit Centers, Cost Centers, and Accounting in
the "Real World"
While some of the best management information comes from detailed
accounting records, remember that
gathering and recording all
that information has a cost. Good managers strike a balance
between detailed records and the effort required to have them.
In major enterprises where costs can vary a lot from year to
year, it's best to perpetually keep records that are as complete as
practical. This is especially true for expense items that have a
major impact on production costs. Good examples are the costs of
livestock feed, herbicides, and fertilizer.
For smaller parts of your business--especially cost centers where
costs aren't likely to vary much for a given amount of
production--constantly keeping detailed records is seldom warranted.
A better approach is often to do a detailed analysis over a short
period of time, gathering information that you can use for some
time.
For example, consider operating costs of a custom forage
harvester.
The custom harvester may keep detailed fuel consumption records
for one cutting season to get an idea of fuel costs per acre or per
ton of forage in various conditions. But keeping accurate, detailed
fuel records every season may not be practical.
On the other hand, it may not take much effort to keep track of
repair expenses for the forage harvesting fleet separate from other
machinery. So that might be done on an ongoing basis.
An analysis of the forage harvesting enterprise in any given year
may then include actual costs for some items, such as repairs, and
estimated costs for other items like fuel. Even without detailed
fuel records, estimated per-ton forage harvesting costs should still
be fairly accurate.
Revised 10/28/2004.
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