Cost centre (business)

A cost centre is a department or function within an organization that does not directly generate profit but incurs costs to operate. Its primary function is to contribute to the organization's overall profitability indirectly, typically by providing support, services, or resources to revenue-generating departments. Unlike profit centres, cost centres are not evaluated based on their revenue generation; instead, their performance is assessed on how effectively they manage and control costs within a predetermined budget.

The objective of cost centre management is to minimize expenses while maintaining a certain level of service or output. Effective cost centre management involves careful budgeting, cost tracking, variance analysis, and implementation of cost-reduction strategies.

Common examples of cost centres include:

• Human Resources: Responsible for recruitment, training, and employee relations.
• Information Technology (IT): Provides technology infrastructure and support.
• Accounting: Handles financial record-keeping and reporting.
• Marketing: Responsible for market research and advertising.
• Research and Development (R&D): Focuses on creating new products or services.
• Maintenance: Ensures the upkeep of facilities and equipment.
• Legal Department: Provides legal advice and representation.

The expenses of cost centres are typically allocated to profit centres or revenue-generating departments based on various allocation methods, such as direct allocation, step-down allocation, or reciprocal allocation. This allocation helps to determine the true cost of producing goods or services and allows for more accurate profitability analysis.

Key performance indicators (KPIs) for cost centres often focus on efficiency and cost control. Examples include:

• Cost per unit of service provided: Measures the cost of delivering a specific service.
• Budget variance: Tracks the difference between budgeted costs and actual costs.
• Efficiency ratios: Measure the output achieved per unit of input.
• Customer satisfaction (internal): Gauges the satisfaction of internal customers who receive services from the cost centre.
• Cost reduction initiatives: Tracks the success of efforts to lower costs.

Effective cost centre management is crucial for organizational efficiency and profitability. By carefully monitoring and controlling costs, cost centres can contribute to the overall financial health of the organization.