What are cost centres and departments?

Our recent blog post on project costing considered how common functionality in accounting systems can provide you with another way of slicing and dicing your accounting data, without extending your chart of accounts, developing bespoke reports, or having to segment costs into tiny fractions.

Next in our series looking at how functionality in accounting software can be put to good use in SMEs, we consider the use of Cost Centres and Departments and how these can help you further analyse your accounts and support budgeting.

What are cost centres and departments?

Like job costing, the use of cost centres and departments in accounting software is simply a tagging process, you don’t reallocate or code the income or expenditure any differently in terms of where it sits within your profit and loss. Either within an individual transaction line, or in the header for the overall transaction, you will (subject to the accounting software you use) have an option to enter a cost centre or department code. These will be set up centrally and may present as drop downs to ensure consistency in their use. Different accounting systems may vary the names of these analysis levels (even calling them analysis levels of analysis codes) but fundamentally what they do is identical. 

By selecting a cost centre or department for the entire transaction or a particular line entry, you are tagging that income or expenditure to the centre/department. Within the standard reporting, you will then be able to pull out a mini-P&L for that cost centre or department. This will return all the entries posted to that code, and only that code. As noted, both income (sales invoices) and expenditure (purchase invoices) can be coded to a cost centre or department. Most accounting software will also offer this as an option on other transaction types too including nominal transactions, credits etc. By offering the opportunity to code at transaction or line level, you can code individual lines on a single purchase invoice to multiple cost centres or departments.

How can I use cost centres and departments in my accounts?

How you choose to use this analysis will really depend on how your business is structured. A business with multiple business units or divisions, all sitting within the same legal entity, may decide to set up each unit/division as cost centres. Then within those cost centres, you may wish to analyse by team e.g., sales, marketing, accounts, administration. Organisations using sales-based commissions will often choose to set cost centres up as regions or sales channels and then use departments for recording commission – coding sales by rep. Where systems allow, you may even be able to allocate customers to specific cost centres or departments to create regional sales lists or assign contacts to sales team members.

There are no hard and fast rules and like all analysis levels, it has got to add value. Whilst it’s not onerous to add a cost centre or department code to a transaction, it is another part of data entry, so you need to be sure it’s worth the effort.   

If there is no natural use for these analysis level immediately, don’t feel compelled to use them, they may come into their own in the future. Whilst from a reporting perspective, it makes sense to implement them at the start of a financial year, because they make no difference to your P&L or statutory accounts, you can set them in motion whenever you like. Just be sure that when you do, you don’t set up codes that risk contradicting each other.   

Benefits of using cost centres and departments

As noted, cost centres and departments stop the unnecessary addition of ledger codes on the chart of accounts. For example, Sales North and Sales South could be replaced by a single ledger code for Sales and cost centres for North and South, allowing you to split this single combined figure by region.

If your business does run sales across different territories, channels (online and field) or by customer type (B2B and B2C) then the use of Cost Centres can be valuable as it allows sales managers to see at-a-glance, their particular figures. It also allows for in year and year-on-year comparisons to be easily reported.

From a budgeting perspective, the same is true. Department or Regional managers can submit their budgets to you, and these can be uploaded and allocated appropriately. When sales and/or purchases come in they can be coded accordingly and over time, you can review budget Vs actual by cost centre or department.

The use of cost centres and departments can provide far more accurate reporting and analysis as you’re working with actual numbers, not having to rely on rule of thumb or historic trends. If you’re trying to identify and correct underperforming teams, regions, or channels you can get to the data you need quickly and easily.