Capacity-based costing in banking

INTRODUCTION

In today's competitive business environment, there is increasing pressure to squeeze every bit of profit out of existing infrastructures and resources. To do this effectively, an institution must understand the nature of these resources, how they are deployed and whether they are deployed as efficiently as they can be. Across all industries, organizations are turning to capacity-based metrics as the means to accomplish this objective.

Unlike manufacturing organizations, many financial institutions have been slow to realize the financial implications associated with capacity-based metrics in their production environments. Understanding capacity, and its relationship to financial operating results, is becoming increasingly more important in an era of shrinking corporate profits, consolidations, mergers and acquisitions. An appropriately implemented capacity-based costing methodology can assist institutions in understanding the impact of capacity on profitability measurement as well as providing the basis for comprehensive resource management performance metrics.

Capacity-based costing in banking was introduced as a costing technique within the Advanced Cost Management (ACM) methodology in a previous article in the AMIfs Journal, titled "Communication and Costing in Financial Services." In this treatise, the focus is more on the specific business value of capacity-based metrics and capacity-based costing. It covers the advantages of two costing methodologies (capacity-based and full-absorption) and in addition provides a detailed overview of the key components and benefits of capacity-based costing. It also includes practical (real-life) applications of results across the organization to support pricing and profitability analyses and integrated resource management. The article concludes with a reemphasis of capacity-based costing as the means for critical dialog between the service user and service provider.

CAPACITY-BASED COSTING VS. FULL-ABSORPTION COSTING

There has been a long running debate concerning the choice of developing unit costs using a capacity-based methodology or a full-absorption methodology. While both methodologies have their advantages and disadvantages, the significant benefits that can be derived by both service providers and service users from capacity-based costing make it the best value proposition, and therefore the right choice, for the majority of financial institutions. Yet, for many financial institutions, the choice between implementing capacity-based costing versus full-absorption costing is not an easy one. Both methodologies have been in place at numerous organizations and for many years, and both have their proponents.

Proponents of full-absorption costing will...