Components of Product Profitability - Revenue

Components of Product Profitability include; revenues, funds transfer prices, operational costs, specific and general bad debt provisions and claims. First - identify revenue

One of the most fundamental issues to be resolved when calculating product profitability is the identification and tracking of income by product. The capabilities of individual financial institutions to extract detailed income information from their transaction processing systems vary. If the amount and quality of information collected and stored at the product level is limited, it may prove too expensive to enhance existing systems and, therefore, other options for tracking income will need to be identified.

In practice, most financial institutions will be able to track fees and interest that are debited or credited to customer accounts as they can be linked to products via the account number. However, income collected by means of cheque or cash (where an account number and hence a product cannot be clearly identified) will require either a change in procedures or the implementation of manual tracking processes. In many cases it will not prove cost-effective to try to track this income by product as it usually represents no more than 1 per cent of total income. This income should therefore be recorded as a pool item, say against a dummy product. The dummy product entries are essential in order to achieve a full reconciliation of total income to the total income figures in other profitability systems.

The identification of interest cost by product may be difficult because of the need to identify and analyse the cost of funds utilised over a period of time and the availability of data relating to average balances and rates by product. For asset type products, such as overdrafts and loans, the financial institutions will need to calculate the cost of funding products and then to set this off against the interest paid. In essence, the objective is to calculate the net interest income position for each product. The net interest income figure, plus associated fees, represents the gross profit before deduction of product delivery and maintenance costs.

Similarly, for liability-type products, such as deposits and high-interest accounts, the financial institutions will need to calculate the income to be derived from use of each type of deposit. In this way, the net interest income position for each deposit product can be quantified.

Insurance-related products are generally supported by the investment fund, but in a bad cycle it is possible that the value of claims paid may exceed the reserves available for a particular policy type. In these circumstances it would also be necessary to estimate the cost of funding the excess and to include this cost in the product cost calculation. In general, insurance funds must be allocated to products to match interest and investment income to the specific policy types in order to estimate product profitability.

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