Profitability
Category: Strategy Implementation
A growing concern
If profitability is the natural target of any type of private business, the top management of a bank may also be sensitive to other achievements, such as a local service to clients or to State companies. This can be the case in a developing country or in a country where the State exerts a strong pressure on the role of the banks.
More and more, however, profitability is a key condition for a further success, because it attracts investors and allows the realisation of the necessary investments (external or internal growth, systems and good people).
The final profitability depends on a series of factors that are detailed below.
Prices
Prices are usually determined at a head-office level. They can be set up, in a first stage, to increase a market share. It can also be a target, later on, to increase them to have a specific activity becoming profitable or more profitable.
In some cases, local managers have the authorisation, within certain limits, to adjust the prices to get a contract. This can be the case, for instance, in the investment banking business. Gaining the lead management of an important corporate new issue can be considered as a crucial factor for the reputation of a bank and therefore conduct the manager in charge to improve the price.
That is why price level is part of a set of performance standards, to be carefully determined and monitored.
Revenues
Depending on volumes and prices, all the operational entities of a bank generate revenues. The level of these revenues as well as the consolidated figure for the whole bank are very usual performance standards, quantified for instance in the budget of the bank. Detailed targets, by activity, product, customer are necessary and have to be followed closely.
Costs
Profitability means final results, after all costs are deducted from the revenue. When working on an action plan, the bank establishes the costs to develop, implement and run a new activity. The main costs to monitor relate to:
Staff: determined by the number of employees, their total remuneration and social costs
Space: the rental or lease value of the buildings used for the activity
Systems: all the systems to run the bank and its branches, either developed internally or bought outside
Equipment: some of them are taken on a annual basis for a part of their long-term depreciation
Communication costs
Marketing
Business development and entertainment
Travel
Others (auditors, legal fees, information services)
The total costs, including the long-term investments, have to be taken into. It could be, within one year, for their total value or for a part of their long-term depreciation.
Margins
Once the total cost of a specific activity is deducted from the revenue, it remains the margin, expressed usually in percentage. The margin is in itself n indicator of performance. Targets very often refer to a level of margin, and the monitoring reflects that objective.
The level of margin is a good indicator of the consistency of the whole strategic plan. For instance, ambiguities about the market share and the profitability objectives could lead to have a branch actually increasing its market share, but at the expense of the margin (for instance, with more marketing expenses and reduction of the prices to attract more clients).
Break-even points
One other way of considering the potential improvement in the profitability of one activity is to determine its break-even point. This indicator is the level where the revenue just covers the costs. All the extra revenues give a profit to the company.
When wishing to increase the profitability of one branch or one product, the bank can decide to increase its revenue, to decrease its break-even point or both. Acting on the break-even point means to review all the items of the costs to see where savings could be done. An optimisation of the services and systems, at a group level, can for instance help to reduce the total costs.
Gross and net earnings by sector, product, customer and employee
All the performance standards described above have naturally to be monitored not only at a global level, but also for each strategic axis of the bank: the economic or geographical sector, the product, the customer, and even the employee.