Definition: A cost center is a department that generates costs but doesn’t produce any revenues. You can think of this as a necessary department that consumes resources but doesn’t contribute to the production, sales, or profitability of the business.
What Does Cost Center Mean?
Some examples of a cost center include the accounting department and the legal department. Neither one of these departments helps produce products or increase sales in any way. They just drain resources from the company. This isn’t to say that these departments aren’t necessary and can’t save the company money in the long-term.
Example
Every large company has an accounting and tax department that employs people who do nothing but record company activities and find ways to increase efficiencies and lower taxes. This department is essential for tax compliance and can’t be closed. Just because the accounting and tax departments are cost centers doesn’t mean that they aren’t valuable to the organization as a whole. If the accounting department can save the company money by lowering its taxable income, it will indirectly contribute to the companies overall profitability.
The same is true about the legal department. Every large company has an in-house legal department that handles anything from small suits to large companywide legal issues. These departments are in many ways essential and can’t be closed. They can also save the company thousands or even millions of dollars depending on the size of the lawsuit, but they don’t actually contribute to the sales or production level of the business. In many cases, these departments often take away a company’s production capacity because they tie up resources that could be used on the factory and production floor.
There are many other common cost centers that exist in different businesses. For example the advertising and purchasing departments of a manufacturer are considered costs centers.
