Time-Driven Activity-Based Costing (TDABC) is a powerful tool for profitability analytics in the banking sector. Unlike traditional costing models, TDABC focuses on two key factors: the cost per unit of time and the time required to perform specific activities. By understanding the time and resources spent on different banking products and services, TDABC provides more precise cost allocations, enabling better decision-making around pricing, resource optimization, and profitability.
Moreover, when TDABC is combined with Funds Transfer Pricing (FTP) and revenue data, banks can generate detailed profit and loss (P&L) statements at the individual instrument level. This granularity allows banks to analyze profitability across multiple dimensions such as products, customers, relationships, credit scores, delivery channels, and even specific customer/member representatives. This capability makes TDABC a comprehensive tool for strategic profitability management.
1. Simplicity in Implementation
Unlike traditional Activity-Based Costing (ABC), which requires detailed data collection for every single activity, TDABC simplifies the process by using two parameters: the cost per unit of time and the time required for each activity. This makes implementation far less complex and easier to maintain over time, which is particularly advantageous for banks with complex operations and many products.
2. Accuracy in Cost Allocation
Other cost drivers, such as volume-based costing, often allocate overheads based on arbitrary metrics (e.g., the number of transactions or revenues), leading to inaccurate cost assignments. TDABC, however, uses time as the driver, which better reflects the actual resource consumption for various banking activities. This increases the precision of cost allocations, resulting in more accurate profitability analytics.
3. Better Reflects Resource Utilization
In banks, resource utilization is often uneven across different products or services. Volume-based methods fail to capture this nuance, often leading to over-costing simple services and under-costing complex ones. TDABC, by focusing on time consumed, reflects real resource utilization more accurately. For instance, the complex loan origination process involved with commercial lending is much more costly than for consumer loans given the additional time spent by the staff involved. In addition, opening a deposit account is much different than originating a loan. TDABC captures this difference effectively by focusing on time.
4. Dynamic and Scalable
TDABC is more dynamic compared to traditional costing models, which are static and often outdated quickly. When new products or services are introduced in banking, or when regulations change, TDABC can easily adapt by adjusting time estimates and cost parameters. Other models, particularly traditional ABC, require recalibration of each activity and cost driver, making it cumbersome to update.
5. Easier to Maintain
Traditional ABC requires frequent updates, as banks need to review and update each cost driver as processes evolve. TDABC, on the other hand, can be updated more efficiently by adjusting the time required for various activities. This makes it far easier to maintain, especially in banking environments where processes and customer behaviors change regularly. Furthermore, in period of salary inflation, TDABC and easily adjust for changes in employee costs without the need to update the time spent on each activity.
6. Supports Granular Profitability Analysis
While other cost drivers (e.g., labor hours, machine hours) are often too generic for detailed profitability analysis, TDABC allows financial institutions to assess profitability at granular levels—by customer segment, individual product, or even specific transaction. Since time data is acquired by individual employee, high-cost processes can be reverse engineered to identify changes that improve employee effectiveness. This level of detail is harder to achieve with volume-based or traditional ABC methods because they rely on indirect cost drivers that don’t reflect the true complexity of the processes.
7. More Relevant to Service-Based Industries
This is particularly true in banking, where around 50% of an institution’s non-interest expense is related to salaries and benefits, and another 25% goes to services that keep employees productive, such as facilities, human resources, computer equipment, etc. In other words, 75% of an institution’s non-interest expense is directly related to the people who do serve customers/members. This makes time the primary driver of product cost. Traditional costing methods, which may focus on volume or other indirect drivers, fail to capture the actual resource consumption in a financial institution. Time-Driven Activity-Based Costing (TDABC), by directly linking time spent to cost, becomes critical in accurately assigning these expenses in service-based industries like banking.
8. Combining TDABC with Transfer Pricing for Detailed Profitability
One of the key advantages of TDABC is its ability to be combined with Funds Transfer Pricing (FTP) as well as other non-interest expense and income data to generate profit and loss (P&L) statements at the individual instrument level. This means that for each financial product—whether it’s a loan, deposit, or other banking service—institutions can accurately determine profitability by assigning the correct revenues, funding costs, and operating expenses. Once P&L statements are available at this granular level, they can be rolled up to provide profitability views across multiple dimensions, including product type, customer segment, relationship, credit score, delivery channel and even individual employee. This enables banks to tailor their strategies for each dimension, optimize their portfolio, and ensure that pricing and services align with profitability goals.
9. Product Pricing with Target ROA and Cost-Plus Formula
TDABC plays a critical role in product pricing by allowing banks to derive cost-plus pricing formulas, especially when targeting a specific Return on Assets (ROA). Once a bank understands the full cost structure of providing a product—through time-driven cost allocations—managers can add a target ROA to those costs to arrive at a cost-plus price.
The formula works as follows: after determining the operating costs for a product using TDABC along with other non-interest expense and income sources, the institution can integrate a target ROA percentage on the product’s capital allocation. This ensures that the pricing of the product not only covers costs but also generates a predetermined level of profitability. This method ensures that pricing is aligned with both cost recovery and profitability objectives, which is essential for strategic decision-making in competitive markets.
10. Resource Optimization
TDABC can highlight areas where resources are either over or under-utilized. By assigning cost to each resource based on the time they are used, institutions can identify high-cost processes, examine them for improvements as well as adjust staffing levels to manage costs more effectively. On the flip side, identification of low-cost processes can lead to an understanding of where competitive advantages for specific products exist that would otherwise go undiscovered.
Conclusion
Time-Driven Activity-Based Costing (TDABC) is not just a tool for more accurate cost allocation—it’s a strategic asset for profitability analysis in the banking sector. With its focus on time as a primary cost driver, TDABC offers a more precise, scalable, and flexible way to understand and manage the costs of banking operations. Particularly in service-based industries like banking, where a significant portion of expenses is tied to human resources and productivity tools, TDABC helps institutions optimize resource allocation, improve effectiveness, and drive profitability.
When combined with Funds Transfer Pricing (FTP) as well as other non-interest and revenue data, TDABC enables the creation of profit and loss (P&L) statements at the individual instrument level, allowing for detailed profitability analysis across a range of dimensions such as product, customer segment, relationship, credit score, delivery channel and customer/member representative. This comprehensive view provides institutions with actionable insights that can inform strategic decisions, making TDABC a critical component of profitability management for the modern financial institutions.
Furthermore, when a target ROA is integrated into the cost structure, TDABC supports cost-plus pricing methodologies, ensuring that pricing not only recovers all costs but also achieves targeted profitability margins. This capability is essential for aligning product pricing strategies with long-term profitability and capital goals, especially in competitive markets where precision in pricing can be the difference between growth and stagnation.