Components of Product Profitability - Funds Transfer Pricing

Components of Product Profitability include; revenues, funds transfer prices, operational costs, specific and general bad debt provisions and claims. Second - calculate net income

The identification of net income 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.

Facilitating these calculations will require the construction of periodic average balances (monthly or quarterly depending on individual reporting requirements) for each asset- and liability-based product, together with an agreement on what funds transfer pricing rates should be used for calculating both the cost and use of funds for each product. The treasury staff of the organisation should be consulted regarding this latter decision.

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