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Ad hoc Judgment to Comprehensive Fact Based Decision - OFSAA Profitability Management (Part 1)

Guest Post by
Imran Aziz, Senior Associate Consultant, Infosys

With growing competition, globalization and increased product variants around the globe, innovation has become imperative. Time after time Financial Institutions have to bring in new products or services to sustain and grow. Most common questions that run across any Chief Executive's mind are - How much should the bank charge for the product/ service? Which segment shall we target? What % of cost shall we pass on to customers and eventually; is this going to contribute to the organization's profitability!!! The bottom line as we all understand looks very simple i.e. Profit = Revenue - Cost.

In most cases the job of deriving the right price is only the most visible part of the overall strategy, but the key to unlock the intrinsic profit lies in analyzing the components of cost and its allocation method for e.g. an activity based costing approach would give far more superior insights as compared to traditional costing for overhead allocation. When we talk about profitability, the challenge does not ends in only adopting the right costing approach but continues till we do the right analysis. As management is more concerned with broader objectives for the benefit of time and faster decision making, they are generally offered with aggregated data to look at 'Big Picture'. But have we ever realized that account level data is also equally important for decision making e.g. the bank wants to offer customized service to high value add customers.

Economic Value Added (EVA) is considered to be an important performance measure that compares adjusted operating profit against the total cost of capital. It is the surplus return earned by a firm after bearing the cost of capital. EVA states that the business should create returns at a rate over and above their cost of capital to be truly profitable. It is derived by deducting Capital charges from Risk adjusted net income and capital charge in turn is derived by combining series of cost components. Imagine what picture you would get, if your cost component is incorrectly allocated and over or under absorbed every time you calculate EVA for different Lines of Business.  

Through OFSAA's Profitability Management (PM) shared infrastructure and data model, financial institutions face the above discussed challenges proficiently. OFSAA's PM has rich allocation features that allow institutions to allocate ledger level data and aggregate account level data for numerous statistical and financial allocations. The tool supports unlimited number of dimensions and hierarchies that can be used to report data from different angle. Using OFSAAs dynamic driver, financial institutions can apportion expenses based on activity based approach and have an improved understanding in what way products, customers, channels etc. are contributing more to the organizations bottom line. With the wake of global credit crunch and implementation of Basel norms another test for banks is to comply with minimum capital requirement. As a result, banks use Risk Adjusted Return on Capital (RAROC) as a vital measure. With OFSAA multi-dimensional modeling and ability to synchronize and incorporate fund transfer pricing in calculations, institutions arrive at more appropriate numbers needed for capital allocation. At the outset, adoption of right cost management approach and OFSAA inherent features enables financial institutions take effective fact based decision instead of mere judgment. 

Look out for Part 2 of this blog series, where I will further detail out my views on leveraging OFSAA Profitability Management features to facilitate fact based decision making.



A very good read. Basic financial concepts have been explained in an easy and effective way and nicely aligned with OFSAA functionalities.

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