Academic journal article The Journal of Bank Cost & Management Accounting

Product Profitability as the Cornerstone of Bank Financial Management

Academic journal article The Journal of Bank Cost & Management Accounting

Product Profitability as the Cornerstone of Bank Financial Management

Article excerpt

This article will explore the use of product profitability as the cornerstone of financial management. The reader will learn the usefulness of baseline product profitability, as well as learn why BLPP management is imperative to compete as a progressive banking institution. Product profitability analysis enables the bank manager to understand the root components of bank profitability, and to make prudent decisions for future financial success.

Product profitability analysis helps managers to find answers to often-asked questions like the following:

Who is my best customer? How much should I charge? Which department is producing the most income? How should I devote limited resources? Are relationships important?

Why have my earnings declined? Is growth good? Can I support growth? Whom should I buy?

How do I test strategic plans? Why do earnings vacillate? How do I stop expense growth?

Should I add more branches? Should I sell a branch? Why am I losing market share?

Why are profits eroding? Why is the bank undervalued? What do the analysts see?

Welcome to the 1990's! If you want to survive in the world of banking, you need to learn the answers to the previous questions before they are asked. Progressive bank management performs that task; it asks the questions and finds the answers first, before anyone else.

What makes a bank profitable? Is it the customers whom the bank serves, or is it the amount of loan and deposit volume that can be generated? Why does one customer receive better pricing than another? Is one department more profitable than another? Banks have been asked these questions for decades. Ironically, the answers keep changing.

Banks have not been successful in truly assessing profitability until the recent emergence of BLPP management. BLPP management examines all profitability through the development of baseline product profitability.

Product profitability has become the cornerstone of bank financial management. Without this baseline, strategic changes cannot be analyzed for success. Without this baseline, customer profitability cannot be determined. Without this baseline, departmental use of limited resources cannot be measured. And without this baseline, a bank cannot succeed.

Banks have always been content to measure profitability as the amount of income returned by the total balance sheet. That is, as long as total net income increases from period to period, further analysis is not necessary. Blind ignorance can be blissful; however, it can also be fatal.

Traditionally, banks examined profitability from period to period, focusing only upon total returns, and perhaps by income or expense category. Figure 1 (see next page) illustrates a typical comparative financial statement.(Figure 1 omitted)

Initial assessment of the financial statement from Figure 1 reveals earnings reductions of nearly $1,000,000, primarily due to increases in the provision for loan losses.

The bank, however, must look beyond the total financial statement. Hidden in the above example is the sale of very profitable loans to another institution (Other Income). The increase in loan loss provision is not due to increased charge-offs, but rather a bolstering of the loan loss reserve at management's direction for future loan growth. This financial statement presents a very distorted impression of the bank's real future economic picture.

The bank does not realize by looking merely at the comparative income statement that expenses are far outgrowing income growth. The long-term ramifications of this financial scenario can be devastating to future earnings. The bank must take corrective action, but does not know where to begin.


In order to assess the true underlying problems of the bank, or to set corrective strategies, the bank financial manager must determine the profitability of the products which produce this financial statement. …

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