A standard profit and loss account tells you what the whole business earned and spent. It does not tell you whether the shop is subsidising the online store, or whether the Manchester office costs twice what the Leeds office does. Cost centres answer that by adding a second label to each transaction: not just what the cost is (the nominal code), but which part of the business it belongs to.
Accounting software calls them different things: cost centres, departments, tracking categories, classes or dimensions. The idea is the same.
Nominal code, cost centre or project?
| Question you want answered | Use |
|---|---|
| What kind of cost is this? (rent, wages, advertising) | Nominal code |
| Which ongoing part of the business does it belong to? (shop, online, wholesale; office A, office B) | Cost centre |
| Which job or contract with a start and end does it belong to? | Project or job code |
The most common mistake is using nominal codes for cost centres: “Advertising – shop”, “Advertising – online”, “Wages – shop”, “Wages – online”. The chart of accounts doubles in size, and adding a third channel means creating dozens of new codes. Keep the nominal codes about the nature of the cost, and let the cost centre carry the location or activity. Project tracking, which suits time-limited work, is covered in project profitability for small businesses.
Designing them
A cost centre structure works when it mirrors how the business is managed.
- Start with the decisions. Which parts of the business does the owner want to compare, grow or close? Those are your cost centres.
- Keep the list short. Three to eight cost centres is plenty for most small businesses. Twenty-five means nobody codes them reliably.
- Each one needs an owner: a manager who is responsible for its results and will look at the report.
- Include a “central” or “shared” cost centre for costs that genuinely belong to the whole business: the accountant, insurance, the owner’s salary.
- Make them stable. Changing the structure every year destroys comparisons.
Example: a café with an online shop
| Cost centre | What it includes |
|---|---|
| CAFE | Café takings, café staff, food costs, card terminal fees |
| ONLINE | Web sales, packaging, postage, marketplace fees, online advertising |
| CENTRAL | Rent, rates, accountancy, insurance, the owner’s pay |
With that in place, a profit and loss report filtered by cost centre shows that the online shop’s gross margin after postage and fees is 18%, against 62% in the café. That is the kind of figure that changes decisions.
Coding rules
Cost centre data is only as good as the coding. Write short rules and put them where the person entering invoices can see them:
- Every income and expense line gets a cost centre. Balance sheet codes usually do not need one.
- If one invoice covers two cost centres, split the lines. A supplier invoice for both café cups and online packaging becomes two lines.
- When in doubt, use CENTRAL and note it, rather than guessing. Reallocating later is easier than untangling wrong guesses.
- Payroll is coded by where people work. Staff who split their time can be allocated by a fixed percentage agreed in advance.
- Bank rules include the cost centre, so recurring costs are always coded the same way.
Reporting and review
Run a profit and loss account by cost centre each month, with a column for each and a total that agrees with the overall profit and loss. Each cost centre owner should see their column. Look at:
- the trend in gross margin per cost centre;
- costs coded to the wrong place (postage in the café is a sign of a coding error);
- the size of CENTRAL: if it keeps growing, some of those costs probably belong to a specific cost centre.
Shared costs and full costing
The direct profit per cost centre is useful on its own. If you also want to know whether each cost centre covers its share of rent and overheads, allocate the shared costs with an agreed key such as floor space or headcount. That is a separate exercise with its own rules; see shared cost allocation in bookkeeping. Where the “cost centres” are separate companies, use proper intercompany charges instead; see intercompany recharges and shared services.
Cost centres are a management tool only. They do not change your statutory accounts or your tax position, but they make the management accounts far more useful.