A cost center is a group of people or a specific department within a company that incurs costs but does not generate profits or revenue. The purpose of a cost center is to support the operation of the business and help contribute to the overall goal of making a profit.
There are different types of cost centers, and they can be classified based on how they relate to the company’s overall structure and goals. Functional cost centers support specific functions within the organization, such as marketing or human resources.
Product cost centers support the production of specific products or services. And finally, natural resource cost centers are those associated with natural resources used by the company, such as land or water.
The main purpose of a cost center is to help management utilize resources in smarter ways. Common examples of cost centers include human resources, accounting, and administrative functions.
Management often uses cost centers to track spending and identify areas where cuts can be made. This can be done by allocating a certain amount of money to each cost center and then tracking actual spending against that budget.
If a cost center consistently spends more than its allocated budget, it may indicate that the department is inefficient or that its costs are too high.
Internal management uses cost center data to increase operational efficiency and maximize profit by utilizing more relevant metrics to internal reporting.