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Product Costing In Practice
The Experience of MicroSave-Africa
David Cracknell & Henry Sempangi

July 2002

Acronyms
ABC CGAP CERUDEB FINCA UMU TPB KPOSB EBS CI Activity Based Costing Consultative Group to Assist the Poorest Centenary Rural Development Bank Foundation for International Community Assistance Uganda Microfinance Union Tanzania Postal Bank Kenya Post Office and Savings Bank Equity Building Society Credit Indemnity

Product Costing in Practice – The Experience of MicroSave-Africa

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Executive Summary
MicroSave-Africa’s work with its 8 Action Research Partners in Eastern and Southern Africa informs this study. It will be supplemented or updated at a later date as our experience with Allocation and Activity Based Costing systems develops. Whilst many micro-finance programmes justify high interest rates on the basis that rural financial intermediation is very expensive, less attention has been directed towards ensuring that microfinance programmes operate efficiently, it is particularly noteworthy that until MicroSave-Africa started working with its Action Research Partners, though several had costing systems none fully costed products. Although costing products and specifically processes is a key step in driving efficiency improvements, an institutional focus on efficiency is at least as important, for example, ASA in Bangladesh, one the most efficient microfinance providers in the world has no product costing system. In the right environment, the benefits of product costing can be considerable. Identifying the source of profitability (and losses) allows a financial institution to focus on promoting their winning products, and redesigning those less profitable. Moreover, a detailed understanding of cost structures allows more informed pricing decisions to be made, and an understanding of processes facilitates improvements in efficiency. MicroSave-Africa’s work with its Action Research Partners has clearly demonstrated that product costing interacts strategically with a huge and diverse range of business areas including pricing, efficiency, outreach, the design of incentive schemes, the identification of the most suitable product mix, marketing, customer service, staffing patterns, profit centre accounting and budgeting. The strategic dimensions of costing are rarely well recognised. Although, ABC allows a microfinance provider to assess the cost of key processes, which Allocation based costing cannot, the choice of which method to introduce should also be considered in relation to institutional capability and range of other institutional factors. Introducing product costing, especially ABC, which is technically more demanding, requires most institutions to have access to training and technical support, which in East Africa is in very limited supply and expensive. In MicroSave-Africa’s Action Research Partners, the identification of loss making products had a significant and immediate impact, investigation revealed a range of explanations including, poor investment efficiency, inappropriate pricing, an unwillingness to decrease rates to depositors when treasury bill rates fell, inappropriate allocation of staff, as well as expensive processes and internal control procedures. Once a loss-making product has been identified further investigation proved necessary, especially in the case of Allocation Based Costing. With declining Treasury Bill rates and greater pressure on the net interest margin, fee based products were found to be consistently amongst the most profitable products. Fees are also charged for the provision of specific services within individual products (loan application fees, withdrawal fees etc.). Whilst costing was the major focus of investigation, it is clear that few of the MicroSave-Africa Action Partners coherently relate the price of a product with its cost of provision, the most common pricing strategy appears to be to perform a cursory review of the interest rates of the competition, though more research is required to understand pricing strategies fully. Making a transfer pricing adjustment, which accounts for the use of internally generated savings to finance a loan portfolio proved to be important in determining the profitability of savings products, but despite this a number of savings based products proved to be losing significant amounts of money. In several instances it appeared that the savings product was priced too competitively – in other cases more process level analysis is required to determine causality.

and where sufficient resources are allocated to complete the costing. Where detailed investigation is required. investment efficiency. 2. but at very different speeds and to differing extents. mobile banking operations. that the results of costing exercise are used strategically. to use costing information in financial modelling. though areas of investigation are focused and targeted by the costing exercise. Costing is institutionalised only when there is evidence that the process is being repeated. When MicroSave-Africa started working on product costing it underestimated the challenges it would face in institutionalising costing within its partner organisations. Initial investigations have looked into. process audit can be used to unpack a particular process. decreasing the cost of particular processes. A costing exercise has more chance of being successfully completed and the results integrated into decision-making processes if there is management commitment. and to move from allocation based costing to ABC. improving the allocation of staff etc. . and therefore needs to be reviewed regularly and against a financial model during the pilot-test phase. Particularly in the case of Allocation Based Costing additional investigations are required to understand the nature of certain costs.Product Costing in Practice – The Experience of MicroSave-Africa 2 Aside from the key results of costing. trained and capable staff. or are investigating. where there is careful preparation of the costing exercise. More sophisticated and capable institutions are able to take the process further and use allocation based costing as the foundation of profit centre accounting. 4. that additional investigations are being performed. This “process of evolution” is occurring in several of our Action Research Partners. 3. Product costing provides information for the development of new products. though in the case of both activity and allocation based costing the information generated is an imperfect estimation. what has MicroSave-Africa learned about the costing process? 1.

high-quality financial services for poor people” 3. Currently. Opinions expressed remain those of the authors. It does this through the following four key outputs: 1. and FINCA Uganda. This is particularly important given the dilemmas posed to African financial institutions in reaching more remote rural communities. 2. “Increased capacity of local service providers and international networks to deliver technical assistance and training on market research”. qualitative market research leads to the development of a product concept. and Equity Building Society (EBS). 4. 1 The authors would like to thank Brigit Helms and Lorna Grace for their insightful inputs to this paper. “Increased capacity of selected MFIs (Action Research Partners) in East and Southern Africa to deliver secure. TPB. A research issue is specified. which is then developed. Centenary Rural Development Bank and FINCA Uganda. Costing is on-going at UMU and CERUDEB and is yet to start in our newest Action Research Partner – Credit Indemnity. The Action Research Partner uses its understanding of the costs of its existing products to develop expectations relating to the costs of its new product and to build a financial model of the product against which progress can be tracked. Unsupported by donors or institutional goodwill high quality. . curriculum development and dissemination”. MicroSave-Africa works with 8 institutions in four countries. refined costed and priced. Under the Action Research programme (Output 2 above). EBS. “Effective project management and outputs quality control maintained”. “Increased knowledge and understanding of product development related issues amongst key stakeholders. and in South Africa TEBA Bank and Credit Indemnity. MicroSave-Africa’s product prototype development process is outlined in Figure 1. in Uganda – Uganda Microfinance Union (UMU). In Kenya – Kenya Post Office and Savings Bank (KPOSB). Product Costing and the Product Development Process MicroSave-Africa’s goal is to promote high quality financial services for poor people. MicroSave-Africa is learning and disseminating lessons relating to product development and the product development process. through research. in Tanzania – Tanzania Postal Bank (TPB).Product Costing in Practice – The Experience of MicroSave-Africa 3 Product Costing In Practice The Experience of MicroSave-Africa David Cracknell & Henry Sempangi1 MicroSave-Africa’s Action Research Partners Programme MicroSave-Africa’s goal is to promote the development of high-quality financial services for poor people. sustainable financial services must make a profit if they are to attain significant outreach. This paper on product costing seeks to draw lessons from MicroSave-Africa’s work with its Action Research Partners on introducing (primarily) Allocation Based Costing Systems. TEBA Bank. This costing paper draws primarily on the experience of costing in KPOSB.

why is it that none of MicroSaveAfrica’s Action Research Partners – some of the strongest Microfinance Institutions in East and South . whether this is through the simpler Allocation Based Costing or more involved Activity Based Costing (ABC) method generally agree that implementing a costing system can bring a range of benefits to a financial institution. • • • • • • • • • • Allows the full costs of delivering products to be identified Identifies hidden costs Determines the profitability or contribution to profits of different products Assists management to better plan the mix of products that they offer Can improve business planning and investment decisions Assists in budgeting and in understanding the variances between budget and actual costs Can be used to determine the viability of new products Can assist financial institutions to make decisions on outsourcing services Facilitates the pricing of current and new products With senior management support.Product Costing in Practice – The Experience of MicroSave-Africa 4 Market Research and Prototype Development Process Overview Research Issue Qualitative Research Plan Qualitative Research: FGD/PRA Concept Development Understanding clients’ needs Costing & Pricing of Concept Product Ready for Pilot-test Quantitative Research: Prototype Testing Refine the Concept into a Prototype Refining/Testing the product prototype Figure 1: Market Research and the Prototype Development Process. Why Perform Product Costing? Advocates of Product Costing. costing can instil greater cost consciousness in staff Box 1: An Unresolved Question If costing products is so advantageous.

Profit Centre Accounting: Using allocation based costing it is a simple matter to extend the costing analysis to allocate costs to profit centres. Pricing: Product costing enables you to directly relate the pricing of a product with the costs of providing the product.Product Costing in Practice – The Experience of MicroSave-Africa 5 The Strategic Context of Product Costing For all of these stated benefits the significance of product costing is only apparent when you consider the strategic context within which product costing is considered. and to set targets and expectations – measuring. for example. the impact of allocating increased resources to marketing on the profitability of the product. especially when combined with MicroSave-Africa’s “Market Research for MicroFinance” tools. ABC goes a stage further and allows institutions to set charges of particular services according to the costs of an individual process. The Strategic Context of Product Costing Outreach Investment s Customer Service Promotion and Marketing Pricing Budgeting Operational Efficiency Product Costing Profit Centre Accounting Incentive Schemes Product Mix Profitability Staffing Product Development Figure 2: The Strategic Context of Product Costing Budgeting: Once product costing has been completed the next logical step is to create budgets for individual products. the financial institution has the ability to increase their operational efficiency through the close examination of the product processes. See MicroSave-Africa’s “Pricing of Financial Services” toolkit. in the case of Allocation Based Costing this entails an additional step of process auditing a particular product or routine/system to deliver that product. Figure 2 indicates the range of strategic issues that knowledge of product costs and profitability can influence. Customer Service: An improved understanding of products and processes is a significant step to improving customer service. . understanding the profitability of certain locations or functions enables strategic decisions to be made. Operational Efficiency: Particularly in the case of ABC.

rationalise product pricing. and having the tools to measure this performance. the items of income and expenditure that the MFI proposes to allocate to different products. it should reflect in the profitability of the institution. f) Make a transfer pricing adjustment as necessary to account for the use of internally generated savings to finance the loan portfolio. Steps in Allocation Based Costing a) Plan for the costing exercise b) Identify products for costing c) Choosing allocation units. A simple worked example of Allocation Based Costing is provided in Annex 1 Allocation Based Costing Allocation Based Costing is a method whereby each line of the profit and loss account is allocated to different financial products on the basis of a logical criteria called an Allocation Basis. Product Costing Methodologies There are two product-costing methodologies. target promotion to profitable products. and in CGAP’s Draft Product Costing Tool. and improve the design of staff incentive schemes. Loan Product 2 and the savings product using the allocation based time taken and non-staff costs are allocated using the allocation base of the relative volume of each product. the institution can work to promote its profitable products and either remodel or improve the efficiency of delivery of its less profitable products. See MicroSave-Africa’s “Staff Incentive Systems” toolkit. In Figure 3. improved staffing levels and allocation. Allocation Based Costing and Activity Based Costing (ABC). more information can be found in MicroSaveAfrica’s “Costing and Pricing of Financial Services. high investment efficiency. enables the design and implementation of more appropriate staff incentive schemes. Staffing Levels and Allocation: Examining staff allocation against activity levels reveals considerable differences in performance in different locations and offers considerable opportunities for saving costs. staff costs are passed on to Loan Product 1. Investments: Under MicroSave-Africa’s Allocation Based Costing – the efficiency of the investment process was examined in two Action Research Partners as part of product costing. d) Deciding on allocation bases – determining the means by which the items of income and expenditure are to be allocated to different products. A Toolkit Manual for MFIs. e) Quantifying allocation bases – applying the allocation bases to the different income and expenditure items. the correct product mix. the optimal allocation of staff. g) Applying marginal cost analysis as necessary . Promotion and Marketing: Promotion and marketing is strategically tied to developing the institutions ideal product mix.Product Costing in Practice – The Experience of MicroSave-Africa 6 Product Mix: Once the profitability of individual products has been determined. this section introduces the concepts briefly. Outreach: Having efficient processes. can increase outreach depending on the objective of the product. Profitability: Product costing can lead to increased efficiency. Design and Implementation of Incentive Schemes: Having a better picture of optimal performance. See MicroSave-Africa’s “Marketing for MFIs” toolkit.

The costs of sustaining activities need to be allocated to the different loan and savings products using allocation based costing techniques described in detail in Annex 1. Once a cost for a particular core process has been determined based on staff time. Conduct staff time estimates for each activity. for example. Following figure 3. Calculate costs per activity – costs are allocated to activities using staff times. However. Drive activity costs to products – the unit cost per activity is multiplied by the cost driver volume per product. and loan monitoring and loan recovery. These activities are categorised into core processes. In most cases a significant proportion of head office costs come under this category. once you have determined the cost for processing a loan application – the logical cost driver would be the number of loan applications. 5. for example number of loan applications. Different processes will have different cost drivers. sustaining activities cannot be driven directly to particular products. 8. An Activities Register or Dictionary is created that summarises activities taking up staff time. . these costs are then driven through to the products on the basis of a logical cost driver. Identify products for costing 3.identify sustaining activities. Plan for the costing exercise 2. loan disbursement. Allocate sustaining activity costs to product – these costs are directly allocated to products using allocation based costing. 6. for example the cost of processing a loan application for a particular product is number of loan applications multiplied by the unit cost of making a loan application. loan application processing. More details about ABC can be found in CGAP’s Product Costing Tool. Steps in Activity Based Costing 1. Assign cost drivers and determine unit activity costs – a cost driver is a logical criteria that is used to allocate an activity cost to individual products. 7. staff costs and non-staff costs are allocated to core processes upon the basis of staff time spent. To take a simple example. 4.Product Costing in Practice – The Experience of MicroSave-Africa 7 Activity Based Costing Activity Based Costing traces costs through significant processes to products. Each product then absorbs costs for processing loan applications in proportion to the number of loan applications made by each loan product. through timesheets. interviews and observation of processes and activities. Ascertain core processes and activities . Product delivery comprises a number of separate processes. Where members of staff do not directly spend time on core processes but rather provide support functions this time is booked to a general category called “sustaining activities”.

Product Costing in Practice – The Experience of MicroSave-Africa 8 Allocation Based Costing Income and Expense Staff Costs Staff Costs Allocation Bases Staff time sheet Product Costs Loan Product #1 Loan Product #2 Non-Staff Costs Portfolio Volume Saving Product #1 Activity Based Costing Income and Expense Staff Time Activities Allocation Core Process A Drivers Product Costs Loan Product #1 # loan applications Staff Costs Staff Costs Core Process B # transactions Core Process C Loan Product #2 Non-Staff Costs Sustaining Activities Saving Product #1 Figure 3: Allocation and Activity Based Costing: from Draft CGAP Toolkit. .

whilst others indicate a preference for ABC. whilst allocation based costing is simpler and easier to implement. which examines core processes.Product Costing in Practice – The Experience of MicroSave-Africa 9 Which Costing Method: Allocation or Activity Based Costing? Choosing between Allocation and ABC is not an automatic choice. Advantages and Disadvantages of Allocation Based Costing Verses Activity Based Costing Allocation Based Costing Activity Based Costing Pros • Fewer steps • Traces (rather than allocates) costs in a cause and effect relationship • Quicker. skills. ABC is technically superior and provides a wealth of processbased information that allocation based costing does not. ABC is a more in-depth approach. Of course the overall institutional environment is a web of different circumstances. some of which may indicate a preference for Allocation based costing. Allocation Based Costing is a quick and relatively simple introduction to costing. which derives a range of benefits. Source: Draft CGAP Costing Toolkit Simply considering the pros and cons of a particular costing method fails to adequately recognize that the institutional environment is also critical in making a decision about which costing method to adopt. but it requires greater time. It is entirely possible for an institution. in which one or other method may be preferable. and institutional commitment. Table 2 presents circumstances. . MicroSave-Africa does not see a conflict between using Allocation Based Costing or ABC. to start with Allocation based costing and graduate to ABC. simpler and less expensive • Allows management to understand how and why • Consistent with income statement costs are incurred • Can be powerful when used to target • Focus on activities that are meaningful to staff additional investigations and management • Identifies drivers of costs and the circumstances or requirements that cause an activity to take longer • Allows management to focus on where to reduce costs through reviewing the key points and expensive activities • Helps management better understand business process Cons • Relies on subjective input • Incorporates an additional step of allocating costs to activities • Simplistically allocates costs • Volume-related allocation • Is more complex. time consuming and expensive to implement bases fail to account for product diversity and over burden “large” • Relies on subjective input products Table 1: Advantages and disadvantages of different costing methods.

Appropriate where there are a number of capable staff. some staff timings may be required but generally fewer than under ABC.. In the case of very large. Table 3 gives an indication of the process required to implement an allocation based costing system. the time taken may be significantly longer. both in respect of the establishing the product costing system for the first time and in performing a repeat costing. Requires strong information systems. Its also important to train several members of staff in ABC to ensure that institutional knowledge of the ABC process remains on departure of staff. . as well as BURO. Where Head Office Costs A significant portion of these costs are likely to be considered are a high percentage of sustaining overheads. Indicative timings are provided for producing an allocation based costing system. often into the due to the extensive investigation processes within loss making required to complete the ABC products process Table 2: Circumstances favouring the adoption of either Activity or Allocation Based Costing MicroSave-Africa’s Approach to Allocation Based Product Costing MicroSave-Africa has worked with seven of its eight Action Research Partners. Staff capabilities Appropriate where staff capabilities are limited. Tangail in Bangladesh to introduce product-costing systems. or bureaucratic organizations. Requirement for training Less More Requirement for technical Less More assistance Need for additional Targeted investigations Less direct investigation required. investigation required. and will therefore be directly allocated.Product Costing in Practice – The Experience of MicroSave-Africa 10 Circumstances favouring adoption of either Allocation or Activity Based Product Costing Circumstance Allocation Based Costing Activity Based Costing Management Information Requires moderate to strong Systems information systems Administrative burden Moderate. Outputs Provides a quick overview and Provides a detailed picture of core enables some “quick wins” processes and activities. Experience Possibly more appropriate Probably more appropriate when where there is no prior there is already institutional experience of costing experience in costing. Higher burden due to the requirement to timesheet activities and validate them. total costs Single product institution Not appropriate Particularly appropriate when there is one dominant process to understand.

Reasons for loss making products have included inefficient systems. but have been able to handle subsequent costing exercises by themselves. 4 hours – less extensive analysis required 4 hours – as it is possible to build on earlier reports. Make a presentation to Senior Management. and when there are staff changes. 2 hours 11 2 hours ARP Costing Team with MicroSaveAfrica ARP ARP ARP 12 13 14 As required As required This will significantly reduce the time taken for data processing Table 3: MicroSave-Africa’s approach to Allocation Based Costing * Timings are indicative and are based on the elapsed time for a relatively competent. in particular the prevalence of loss making products. highlighting the assumptions taken. However. the importance of accounting for the subsidy implicit in using deposits to finance the loan portfolio and a lack of coherent pricing strategies. Most ARPs have required support from MicroSave-Africa on the first round of costing. . noting areas in which the costing process can be improved and strengthened. as costing spreadsheets already created.Product Costing in Practice – The Experience of MicroSave-Africa 11 Step Action Indicative Indicative time Responsibility for Time for for Repeat first first Costing costi costing* ng 2 hours Not required As before Over the course of one week 1 day 1-2 days Data collection exercise built into normal reporting cycle. there has not been sufficient experience in introducing ABC within MFIs for us to create representative timings for ABC. draw up list of Action Points. to enable the collection of data on front and back office timings – and collect data Complete time sheets for allocation based costing (where necessary) Work with the product costing team to allocate costs and summarize results Document the process and analyse results Poco tiempo Prepare a report for Senior Management. Key Results MicroSave-Africa’s experience with its Action Research Partners enables us to identify a range of common results. the bases of allocations made. average sized MFI. Not required 1 day (validation) MicroSave-Africa ARP ARP ARP 1 2 3 4 Brief the Management of the Action Research Partner on the product costing process Choose a costing team leader and assemble the team Choosing representative branch site Ensure relevant background information is being gathered Train / Expose the product costing team to Allocation and / or ABC normally in a workshop environment Train the product costing team in direct observation. where this has been a well-established product it has surprised management. examining each of these in turn: Almost every institution has a loss making product Most ARPs have at least one loss-making product. the key results and suggestions for follow up. Perform follow up activities After 3-6 months re-perform costing exercise Consider making changes to your accounting and budgeting system to enable most of the Product Costing to be produced automatically 5 6 MicroSave-Africa and ARP MicroSave-Africa and ARP MicroSave-Africa input into drawing up timesheets MicroSave-Africa and ARP ARP reviewed by MicroSave-Africa ARP 7 8 9 10 3-5 days 2-4 days 1-2 days 1 day 1 day (Validation if necessary) 1-2 days. the stability and profitability of fee-based products.

d) Lengthy account opening procedures. which had already reached historically low levels. Expensive. A highly centralized structure.Product Costing in Practice – The Experience of MicroSave-Africa 12 inappropriate pricing. Further investigation revealed that for higher savings balances the interest rate margin on the product was actually negative! This had been caused by a sharp decline in investment income. b) Policies encouraging rapid staff movement enhanced internal control but increased costs. revealed that the cost to the Bank of a single deposit transaction was Ksh. There are numerous examples of this. A review at the Arusha branch revealed that a small number of depositors held 55% of outstanding deposits. these changes can increase costs. As a result KPOSB is now considering transferring some salary accounts to the more efficient. there are numerous examples of inappropriate controls: a) An organisation with newly computerised product retained manual controls which computerisation had made redundant. Centralized Procedures or Internal Control Systems: Internal control should enhance the profitability of products through reducing risk. Equity tied the Fixed Deposit interest rate to the rate prevailing on Treasury Bills. FINCA Uganda is better able to estimate how far their field staff should travel from the office. and an over-reliance on interest rate margin. TPB were reluctant to decrease interest rates to depositors. Head Office Overheads: Without very careful cost control. allocation based costing can rapidly identify areas of high costs for further. Amongst their product range was a Fixed Deposit offered at highly competitive interest rates negotiated on a deal by deal basis. An investigation. generous travel and educational allowances and a large number of support staff were all contributory factors. When costing showed Fixed Deposits to be losing money.52 – 58% more than the cost of a deposit under the Bidii product. c) Lengthy back office approval procedures for relatively small withdrawals. and the expense of introducing new products. KPOSB responded with a new promotional campaign and worked on a new needs assessment and new prize structure. The product costing made the problem more transparent. high head office overheads. computerised Bidii product. sticky pricing. particularly in manual accounting systems. In the case of one Action Research partner. the majority of its costs relate to the head office. The development of a costing system is assisting the bank to take corrective action. which discouraged applications e) Unnecessary production of supporting documentation and records Allocation based costing is less able to identify specific expensive procedures or internal control systems than ABC. KPOSB noted that their Premium Bonds prize pool was greater than the income being generated from investing the premium bonds. However. Inefficient Systems: KPOSB recognised that if it improved its systems it could make significant savings on the costs of operating salary accounts. which costed salary transactions within the OSS product. which had not been reflected in the interest rates paid to depositors. there is a tendency for head office costs to escalate. However. Using the information generated by the ABC exercise. Half Sighted Pursuit of Core Objectives: This occurs when an MFI prioritises a goal without attaching the caveat subject to cost. controls grow and change over time. FINCA Uganda’s ABC exercise revealed that field officers spend a considerable time travelling to groups rather than performing more productive activities. reflecting declining Treasury bill rates. more . or paying interest rates on deposits that are too generous. Equity Building Society had just achieved the highest rating of any financial institution under the GIRAFE rating methodology it was growing rapidly and was popular amongst its clients. serving a particularly remote rural community or opening mobile banking operations in areas where there is insufficient demand. Sticky / Inappropriate Pricing: The Domicile Quick Account of Tanzania Postal Bank appeared to be very successful it was attracting significant deposits from the public.

allowing inefficient banks to operate profitably. There is significant surplus liquidity in the financial system. East African Banks have to become more efficient. which are an important hedge against interest rate risk. New Products: New products make losses. there is no evidence that these fees have been established scientifically on the basis of the costs to the bank of providing that service. for statements. withdrawal fees on notice accounts. either costing system can be the starting point for an investigation into processes and procedures. with globalisation of financial services. in the months after launching its Grow With Us product TEBA Bank had incurred losses of more than $70. high Treasury bill rates. This liquidity is a response to economic instability. fees for withdrawals. for processing transactions. and more international competition. The average liquidity reported by the Central Bank of Kenya is around 45%. Stability and Profitability of Fee Based Products Historically East African net interest margins have been very high. provides the opportunity to track variances.000 with up-front investments in information technology. Fees are commonly charged for the provision of services within a product. and the time taken to build a customer base. uncertain foreign exchange cash flows and conservative banking practices. Product costing enables the institution to see whether the loss is in line with projections. and take early corrective action. The interactions of costing and new product development are explored later in this paper. Fee based products in particular money transfer products. training etc. The ABC method is particularly useful at establishing the fee rates for particular services. Figure 4 shows that treasury bill rates have fallen dramatically particularly in Tanzania. Bank of Tanzania website Falling Treasury bill rates have provided a renewed impetus to designing and developing fee based products. with many institutions holding even higher liquid reserves. freely floating exchange rates.Product Costing in Practice – The Experience of MicroSave-Africa 13 detailed investigation. in promotion. However. for KPOSB and TPB and a credit bureau service for TEBA have proven consistently profitable. 91 day Treasury Bill Rates in Kenya and Tanzania 25 20 Rate 15 10 5 0 Ja n00 M ar -0 M 0 ay -0 0 Ju l-0 0 Se p00 No v00 Ja n01 M ar -0 1 M ay -0 1 Ju l-0 1 Se p01 No v01 Ja n02 Tanzania Kenya Fig 4: 91 day Treasury bill rates in East Africa: Source: Central Bank of Kenya website. are examples. However. .

Banks recognise the need to account for “hidden” cross subsidisation through transfer pricing. Before Transfer Price After Transfer Transfer Adjustment Price Price Adjustment Adjustment Ordinary Savings -44. as it assumes a zero cost of funds.Product Costing in Practice – The Experience of MicroSave-Africa 14 Profitability and the role of Transfer Pricing MicroSave-Africa has found the profitability of particular products to be particularly powerful in driving change within its Action Research Partners. (1992) adapts an example of Copeland. The question becomes what rate of interest should be applied as a transfer price: The marginal rate at which an institution can borrow funds – This approach argues that the full opportunity cost of capital should be charged.8 22.5 Table 4: Example transfer price adjustment The transfer price adjustment is calculated on the basis of the average outstanding loans whose funds have been sourced from deposits multiplied by a notional interest rate. which is the source of core deposits in order to correctly value the retail and wholesale divisions. or even to the profitability of individual branches.8 37.4 Short Term Loans 47. In the example below before a transfer pricing adjustment the profitability of the business loan is overstated.5 21. and therefore no reliable performance measures could be put in place. When this institution used its long-term investment rate to calculate the transfer price it discovered that business savings and short-term loans underpin the profitability of the bank. Koller and Murrin (1990) where a transfer price is charged to banks’ wholesale lending division and credited to a banks retail banking division.5 6.6 -28 Business Savings 14. Sinkey.9 1. MicroSave-Africa has adopted a simple transfer pricing approach in its costing exercises where deposit products finance loan products. Joseph F. The notional interest is allocated back to savings products in proportion to their contribution to the source of funds.9 Fixed Deposit -20.2 -10 37.” Standard Bank now credits a notional income to branches based on the number of accounts opened the costs of account maintenance and a transaction fee.6 Other 11.2 Business Loans 68. One challenge in deriving the profitability of individual products is how to account for the implicit cross-subsidy between deposit and loan products where deposits are a source of capital for lending.9 22. Similarly Standard Bank in South Africa recognised the need to eliminate cross subsidy when introducing their ABC system (Putter et al.6 16. . this is to say the cost at which an institution would have to borrow funds in order to finance their loan portfolio were deposits not being used. Jr.) “Standard Bank … implemented a sophisticated transfer pricing system (also based on costing information) to eliminate unseen cross-subsidisation between different areas of the bank” The Bank noted that “No reliable information was available regarding product or customer profitability.8 -5.3 -45.

however. Trained and capable staff: Allocation based costing is not a difficult exercise. or where funds are rationed internally. b) The price charged on other savings or loan products by the institution (often in an attempt to prevent cannibalisation between products). customers responded very quickly. (See Box 2) Conversely. James Mwangi the Finance Director of Equity stated his heavy involvement in the process allowed him to take the costing process further and faster than he would otherwise. The senior management or board should set the transfer price according to the circumstances of the MFI or bank. those institutions with better trained. the training and mentoring approach becomes even more important.5 to make elsewhere. though even this has usually been done without systematic and detailed competition analysis being performed. exposure to the principles of allocation based costing in a workshop combined with technical assistance is a successful way to create a costing system (See Table 3 on MicroSave-Africa approach). which were high in relation to the payment being processed. The price of an individual product tends to reflect either a) The pricing on similar products from close competitors. Equity Building Society learned that clients complained about a range of fees and charges they felt were unrelated to the value of the services they received. which the customer would pay Ksh. It is the rate MicroSaveAfrica normally applies. If pricing products is inconsistent. due to significant changes occurring within the Bank. customers also objected to fees. Key Lessons What Does it Take for a Costing Exercise to be Successful? Management Commitment: Management need to be fully involved and committed at all stages of the costing process. before the changes were made the Society was losing 300 salary accounts per month – two months after the change and they were gaining 300 accounts per month. Customers objected to paying KSh. When Equity rationalized their fee structure for certain products. The long-term investment rate – This approach argues that the long-term interest forgone on investing deposits longer term should be charged to loan products.20 for Equity to make photocopies of documents for opening an account. more competent and capable staff found the introduction of either costing system to be much easier. pricing services appears even more so – to the extent that customers sometimes complain bitterly. which is conceptually more difficult. in Centenary Rural Development Bank the costing exercise has not been completed partly because of insufficient management support to the exercise. . During market research performed with MicroSave-Africa. Lack of Coherent Pricing Strategies Few of MicroSave-Africa’s East African Action Research Partners have consistent and coherent pricing strategies.Product Costing in Practice – The Experience of MicroSave-Africa 15 This approach is appropriate either in markets where subsidised funds are available as in the case of many donor supported MFIs. d) Setting relatively high prices in order to generate returns for shareholders. and in some cases c) An institutional mission to provide a service at a low price or to provide high returns to their customers. almost none have priced their products or services in relation to the cost of providing that service. Financial projections indicate that over time the increased demand will more than compensate for rationalizing the fee structure. In the case of ABC. Amongst our partners.

develop and use financial models h) There is evidence of product cost information being used as a determinant or co-determinant of pricing products i) There is increased use of responsibility and/or profit centre accounting j) Costing information is fed into the institution’s budgeting process k) There is a greater knowledge and understanding of key processes l) There is evidence of increasing cost consciousness within the institution. For allocation based costing the resource requirement is modest. Unfortunately. which requires greater data gathering and absorbs correspondingly greater resources. this usually entails: a) Train costing team in allocation and / or ABC b) Ensure technical support is available should the MFI require this c) Provide sufficient time from other responsibilities for staff to complete the costing process – in the case of ABC this includes time to produce and analyse time sheets. for example i) Product policies ii) Procedure manuals iii) Detailed accounts iv) Trail balance v) Transaction levels by product vi) Staffing by location and type vii) Details of investment income Resources: Where costing processes were introduced quickly and efficiently sufficient resources were allocated to the process. . and as much of the process as possible is automated f) Increased resources are devoted to understanding product and institutional costs g) Use of the costing information to design. it underestimated the challenges we would have in institutionalising costing. within an Action Research Partner. d) Gather together key information. Careful preparation significantly reduces the time and effort involved in developing a product costing system. FINCA Uganda committed five staff members for 10 days to gather and process the data. understand and utilize the results of product costing have increased c) A demand by management for the costing information exists d) Strategic and ongoing use is made of the information generated e) The product costing process is built into the accounting and management information system. a costing champion as well as a designated deputy who would take over future costing exercises should the costing champion leave was needed. Careful preparation: Although costing as a process differs in every organization and between costing methods. Costing as a Process When MicroSave-Africa started working on product costing. which could include the adoption of ABC. in East Africa technical assistance to support the introduction of product costing systems is limited and expensive. From MicroSave-Africa’s experience. For example. The team leader then spent several days analysing the data. a small team of 2-4 people can normally produce an allocation based costing system within an institution with a good management information system within a week. ABC is a more complex longer process. MFIs with limited experience or skills in costing require short term technical assistance to introduce allocation based costing. and greater technical assistance to introduce ABC. The signposts to recognize whether the costing is being institutionalised might look something like this: a) The ARP continues to perform product costing regularly with less frequent involvement of MicroSave-Africa or other technical assistance providers b) Capacity to perform. the initial preparation for the costing exercise is in practice very similar.Product Costing in Practice – The Experience of MicroSave-Africa 16 Graham Muller of Graham Muller and Associates based in South Africa who has practical experience in both Allocation and ABC went further to say that in order to institutionalise costing. interview staff and perform detailed observations.

medium and even long-term decisions. Nevertheless it is a significant tool. In the case of Equity Building Society the commitment to the process was a result of the Finance Director. Knowing which products are the most profitable enables management to make rational decisions on their product-mix over the short and medium term. and commitment of the institution to the process. James expects to see additional benefits as his management team becomes accustomed to using the information the costing system is generating and as he moves towards developing an Activity Based Costing System. even customer satisfaction (see Box 2 for full details). For Equity Building Society. the board or the staff of a financial institution. measuring the profitability of products is important as it stimulates targeted action. Why Analysing Profitability Matters Aside from a few microfinance interventions. Considering costing as an evolutionary process is particularly appropriate in a country or institutional context where skill-sets and understanding take time to mature and develop. progress can be very rapid indeed. In the case of KPOSB. as the case of ASA in Bangladesh. in disasters or post conflict situations. In practice. valuable but occasional. ways to enhance efficiency. Allocation based costing does not provide as much information about products and processes as ABC. profitability. but are worthy of repetition: Costing as a process evolves as a function of the capacity. clearly demonstrates. the heavy losses on the premium bond product stimulated a marketing campaign to promote the product. Profitability as an indicator facilitates short. A product costing system is not a pre-requisite for efficiency. (one of the world’s largest and lowest cost providers of microfinance services but has no product costing system). Much has been made of the need for Microfinance Institutions to charge high interest rates to cover the costs of providing rural financial services. seeing their fixed deposit product losing money through offering over-competitive interest rates stimulated an immediate response. Over a longer time scale investigations can target the design. they are significant. In institutions where there is clear capacity and institutional commitment. In the very short-term promotion campaigns can focus on particularly profitable products. but it is much simpler and as the case study shows – it can produce significant results. There is a risk with ABC. During the space of 10 weeks the James enacted a range of “quick wins”. Profit has long been used as an indicator of success. Although ABC is a better tool for examining core product processes an advantage of allocation based costing is that it fits within the existing financial reporting structure of a Bank or MFI. nevertheless. as a concept it needs no explanation to the management. James Mwangi being involved as he could see the value of the information generated from the product costing process. such as dealing when with the very poor. particularly as it is more involving and more time consuming. which are may be self-evident. pricing and efficiency of less profitable products and the design of incentive schemes and staff appraisal systems can be modified.Product Costing in Practice – The Experience of MicroSave-Africa 17 m) More efficient processes within the financial institution Several key issues come out of this analysis. . that it becomes a special purpose exercise. less emphasis has been placed upon the need for the same institutions to control their costs and to work in an efficient manner. Clearly these are rapid responses that have not resulted from a detailed investigation of product processes. staff performance measurement. In the short term falling Treasury Bill rates in Tanzania have a less immediate impact on management than seeing the financial implications of a decreasing net interest margin on the bottom line. Once performed it can be easily adopted within the institutions existing budgetary and monthly reporting process. to re-price their product. organizations providing microfinance must become fully financially sustainable in the longer term this should include making a profit after sustainability adjustments have been included as calculated in the “Micro-Banking Bulletin”.

firstly. b) Under ABC – the challenge is in the changing nature of a new product and its processes. Actual performance is measured against projections and adjustments made to the model as necessary. secondly. but to test for the financial viability of the product before it is launched system-wide. Firstly. the core processes themselves are likely to change. without volume there is a tendency for the product to under-absorb costs. new products make a loss . thirdly. This involves closely modelling costs. in which case. design. Information Systems Good information systems make introducing product costing much easier. from marketing to portfolio building. information technology. which measures these incremental costs. Clearly regular review of both costing systems would be required if the costing system itself is to provide accurate information. Under ABC . “What additional costs has this product incurred and what additional revenue has been generated? Thereby allowing the financial institution to see whether a positive contribution to the costs of the institution has been generated. The marginal costing approach essentially answers the questions. MicroSave-Africa recommends that financial institutions control costs through adopting a pilot testing approach to new product development. Understanding the costs of a new product is essential for correctly pricing the product. promotion etc even before the product start to contribute to head office overheads or sustaining activities. . The Draft CCAP Product Costing Tool notes: “For all the benefits ABC also has its drawbacks.where a product follows the same processes as other products – an approximate cost can be assumed from costing the related product. secondly. Under either method. Ideally before the start of the pilot test an institution develops a financial model.it takes time for products to generate the demand to repay the costs of market research. in practice this may not happen. MicroSave-Africa is building in the results of product costing into pilot tests and financial models currently being designed. The cost of developing new products can be considerable particularly where information technology costs are concerned. a new product calls disproportionately on head office support services. a) In the case allocation based costing – the challenges are several. This pilot test is designed not only (or even primarily) to test the system supporting the product. MicroSave-Africa intends to explore product pricing in more detail in a future paper. the balance between activities changes rapidly. staff may not properly understand the core processes of a new product. Until the product goes to scale and rolls out across the system. the more potentially valuable ABC costing becomes but the more challenging the information gathering process is. in the short term – a marginal costing approach will give the earliest indications of product profitability.” As processes become more complex. especially those allocated on the basis of transactions. examining marginal costs and carefully setting price levels. In the absence of a product costing system or understanding of detailed processes that comprise a product. the product costing system provides at best an estimate of the costs of new products rather than an accurate picture. pricing a product becomes more of an art than a science. it is difficult to finalize the costing of a new product under either method of product costing. The requirement to integrate activity levels with general ledger information can become a real bottleneck. A full ABC model requires a significant amount of detailed process level information and probably is beyond the scope of many MFIs information systems. to portfolio maintenance – leading to rapid change in staff time allocations.Product Costing in Practice – The Experience of MicroSave-Africa 18 Implications of Product Costing for Developing New Products Almost without exception.

Taking the costing forward through additional targeted investigation adds value. test site. a process-audit can be undertaken on a specific product. In the case of Centenary Rural Development Bank. Within our partners the following investigations have been carried out or are proposed. such as providing incentives to loan collection committees or paying a debt collection agency. and to audit of Tanzania Postal Bank’s Domicile underscore the implications of falling Treasury Bill Quick Account Product in the Arusha pilot rates on the profitability of the institution. which had limited value. at the time. its current information system does not support the level of detail required to drive the activity costs to the ten products that the bank is offering at the moment – all they can do is to ascertain the costs of each of the activities and core processes. the mobile banking operations: to determine where and added 30-45 minutes per day to the mobile banking operations should be operated. The Centenary Bank expects to introduce an updated information system during 2002. where allocation based costing has revealed the requirement for additional research. the product costing team will not have answers. the time-sheeting and interviewing process to develop staff time analysis took a team of five people an elapsed time of more than five days. and the weekly group meeting as their most expensive processes. Under a process audit. in determining where and how staff should be allocated. an example of part of a process audit associated with ASA’s lending methodology is presented in Annex 2. In larger. Box 1: Improving the Process at Tanzania Measuring the efficiency of treasury operations: Postal Bank analysing actual against potential yields from investment opportunities to explain low levels of MicroSave-Africa carried out a process investment income in Tanzania Postal Bank. mapped out and timed. more complex institutions with more varied staffing patterns the process can take much longer. to which.Product Costing in Practice – The Experience of MicroSave-Africa 19 For FINCA Uganda. Calculating the cost of following up delinquent loans allows FINCA Uganda to price a number of alternative collection strategies. which has one dominant product. Taking Product Costing Forward: Additional Investigation A product costing exercise is not an end in itself – it will raise a significant number of questions. . However. Process Audit The chief advantage of ABC over allocation based costing is that it relates costs to processes. Reducing the cost of agency procedures: TEBA Bank can use process audit to examine areas in which TEBA Bank’s agency procedures can be streamlined. Allocation of staff: examining activity levels within different products and at different locations has proven useful for both Tanzania Postal Bank and Equity Building Society. cashiers closing routines. A process audit will not relate costs directly to a product process. but does allow efficiency to be improved. The process audit revealed that Internal Audit had added an additional Performing break-even and sensitivity analysis on manual control. Decreasing the cost of following up delinquent loans: FINCA Uganda has just completed an ABC exercise it identified the cost of following up delinquent loans. every process within the delivery of a product is identified.

This led to the establishment of performance benchmarks by transaction for all staff. 3. on a branch-by-branch basis. although the Finance Director is driving the process. Equity Building Society now confidently projects increased income from these accounts based on a significantly increased volume of business. calculating the break-even point of different mobile banks. Equity studied the costs of the mobile banking operation. 5. James Mwangi who completed the costing exercise himself with support from MicroSaveAfrica. branches are rewarded not on the number of new accounts they open. decreasing fees reduced income in the short term it had a dramatic impact on the number of people opening new accounts. Attributed an increased range of direct costs to branches – instead of absorbing costs centrally. many of the changes above have been noted by staff throughout the organisation. 8. by branch and by cashier. Performance between cashiers in the same branch was noted to vary considerably. Secondly. and the lessons that were being extracted fascinated the Finance Director. It is looking at the implications of fully allocating costs to branches. 10. staff training for example.Product Costing in Practice – The Experience of MicroSave-Africa 20 Box 2 . Increased standardization in accounting for costs after the allocation based costing exercise noted that different members of staff coded expenditure in different ways. 4. Changed fee structures on salary accounts. to track direct income in relation to direct costs of provision. 7. and may lead over time to additional performance-based incentives. This allows Equity Building Society. Although a product costing team created most of the original allocations. Activity rates are being tracked daily. the costing process. some branch cashiers have been reallocated according to workload. but the number of accounts of a particular type.Costing at Equity Building Society Equity Building Society adopted Allocation Based Costing. Changed the method of appraising staff performance to include tracking activity rates. 9. in November 2001. Increased mining of the strategic data available to management. Equity: 1. . 2. and so to manage product mix and to respond to changes in the margin very quickly. in one branch some cashiers achieved 80 transactions per day others more than 200. Reallocated resources – resources and attention are directed towards high value products. Management perception towards costs and cost control has changed. This is likely to lead to closing some mobile banks and opening others. Decreased Fixed Deposits interest rates are now tracked against available Treasury Bill rates on a weekly basis 6. Less than three months after the costing exercise the following tangible benefits were reported. Adjusted the chart of accounts to reflect direct income and direct costs on a product-by-product basis.

3. Already after only three months it is impacting upon many of the strategic decisions being made within the organization. The costing we have performed so far has enabled us to identify some of the factors that are driving costs within the institution. Costing does create some tensions. Costing has already become an indispensable tool of management to the extent that I wonder how we survived before the costing was undertaken. 2. it is the cause of some anxiety – “How am I to package certain costs to the staff. Changes to staff appraisal systems. Develop an ABC System to build on the allocation based costing system already developed.Product Costing in Practice – The Experience of MicroSave-Africa 21 Comments from the James Mwangi Equity Building Society’s Finance Director: “Allocation based costing allowed Equity Building Society to obtain a range of “quick wins”. ABC will provide returns over a longer period. During 2002 Equity Building Society plans to: 1. Instigate a branch costing system Box 2 Costing at Equity Building Society . Increase awareness of costs and cost control amongst branch managers. and increasingly booking overheads at branch level will be backed up by training and exposure in costing and process analysis. are they going to accept these costs?” Until now there has been little effective cost control on senior management. but it requires additional resources and commitment from the part of the society. making costs more transparent is key in controlling these costs”.

Costs are allocated to products by working down the Profit and Loss Account line-by-line. deciding on what basis each line or Allocation Unit. Allocation Unit Interest income . of the institution. % Amt.5 5% 0.0 100% 316.0 291.0 115.0 266.8 65% 16. The stages covered are as follows: a) b) c) d) e) f) Choosing Allocation Units Deciding on Allocation Bases Quantifying Allocation Bases Making a Transfer Pricing Adjustment Final Costing of Products Marginal Costing Choosing Allocation Units Allocation Units are the items of income and expenditure that are going to be allocated across the different products.0) 75.0 6. Lastly Marginal costing analysis is used to assist management in making decisions related to loss making products.0 100.0 366.8) 128. reflecting the fact that capital for lending is mobilised from savings.0 50. Next a notional charge or transfer price is levied on loans and applied to savings products.8 Direct Staff Time Area Staff Time Transaction Actual Figure 1: Choosing Allocation Units .0 75.0 100% 50. the allocation bases are quantified. In most cases.0 80% 60. as per a/cs 316.0 25.0 10.OLA Interest income – Investments Transfer Pricing Adjustment TOTAL INCOME Interest expense Staff salaries etc.2 (28.0 35% 8.5 55% 5.0 Saving Loan Product Product % Amt. 0% 0.0 0% 35% 40.8 20% 15. as in the case below this follows the institutions chart of accounts. should be allocated.0 35.3 65% 74.0 (25.8 162.Product Costing in Practice – The Experience of MicroSave-Africa 22 Annex 1: A Simple Worked Example of Allocation Based Costing This worked example provides an easy introduction to costing products using allocation based costing. Rent Motor vehicles Insurance Communications TOTAL EXPENSES Net Result Allocation Basis Direct Portfolio Amt.3 95% 5. and used to allocate costs to different products.0 0% 25.0 100% 35.7 103.3 45% 4.

0 0% 25. E. high proportion of any item is allocated to the core (or primary) product and a small residual element split across the other products . E. E.7 103. money transfer services/remittance products.0 75. when different levels/salary structures of staff deal with different products The total number of transactions per product over a defined period as a percentage of all transactions.g. rather than in total. using amounts on deposit and/or amounts loaned (i.0 10. the costs of the CEO’s office to the products of the organization. Balance Sheet basis).0 (25. E.3 95% 5. Where staff are involved in transactions at a detailed or direct level.5 5% 0. The relative average proportions of the product portfolios over a defined period of time in terms of direct income or expense by product.0 Saving Loan Product Product % Amt.5 55% 5.3 45% 4. % Amt.g.g.8 162.e. interest paid on savings products or (in some cases) transport. accounts entitled “sundries”.OLA Interest income – Investments Transfer Pricing Adjustment TOTAL INCOME Interest expense Staff salaries etc.0 100% 35.0 115. rent or depreciation charge for buildings Where each product is given an equal share of an item of income or expenditure. E.g. a two-step process. Rent Motor vehicles Insurance Communications TOTAL EXPENSES Net Result Allocation Basis Direct Portfolio Amt.0 80% 60.8) 128. Based on the actual office space consumed by the product or department in terms of area allocated. Allocation Unit Interest income . the estimated split of their time across the different products.mainly used in Marginal Costing.0 25.0 100. as per a/cs 316.8 Direct Staff Time Area Staff Time Transaction Actual Figure 2: Deciding on Allocation Bases Examples of Allocation Bases Basis Direct Staff time Direct numbers staff Application Where the expenditure or income item relates solely and entirely to one product. loan loss provisions. E. 0% 0.0 366. E.8 20% 15. (See below) Where a fixed.8 65% 16.0 266. computer systems costs For account lines consisting of ad hoc individual items which need to be allocated on an actual transaction-by-transaction basis.0 35% 8.0) 75. the costs of the CEO’s office to the products of the organisation. office stationery or utilities such as electricity Based on the actual number of staff positions allocated directly to a product.g. Where the costs of a department are first absorbed into other departments or cost lines before then being allocated using another basis i. for generic institutional advertising. E.g. a description of different Allocation Basis is provided in Table 1. when some staff are specifically responsible for specific products or for utilities such as water the consumption of which is unlikely to vary with differing staff levels Based on the salary costs of staff positions allocated directly to a product.g. (See below) Where a cost or income item is taken to be fixed and therefore independent of product performance.e.0 0% 35% 40.0 291.0 35. and is allocated to the core product under the Marginal Costing.Product Costing in Practice – The Experience of MicroSave-Africa 23 Deciding on Allocation Basis Allocation Bases refers to the method by which the allocation units are spread between different products.g.g.0 50.3 65% 74.2 (28. Direct staff cost Transaction Actual Portfolio deposit base Portfolio investment income base Area Equal Absorption “Core product” Fixed – – Table 1: Examples of Allocation Bases . This is particularly useful when products do not result in Balance Sheet assets/ liabilities e. The relative average proportions of the product portfolios over a defined period of time. E.g.0 100% 316.0 100% 50.0 6. (See below). E. and it would normally vary directly with transaction activity or value on that product.g.

The basis will differ from institution to institution.0 50. If there were two deposit products investment income would be apportioned to each product in the ratio at which each product contributed to the funds being invested.Product Costing in Practice – The Experience of MicroSave-Africa 24 In choosing which allocation basis to use it is important to consider what makes the most sense for your institution. it is possible to separately identify all of the interest income from the loan product.0 100% 316.0 75. so this is allocated to the savings product.0 35% 8.3 65% 74.0 (25.0 100% 35.3 45% 4.0 366.0 115. Similarly investment income is derived from investing depositors’ savings.0 35.0 0% 25.8) 128. In this example it may be the vehicles are predominantly by loans officers to follow up defaulting clients and by savings officers to market the savings product and that a reasonable proxy for the time spent is staff time. Where this information is available. and what information about particular allocation bases can be provided by your information system. On what basis should Motor vehicle expenses be allocated between the savings and loan products? It is not at all obvious. At this stage the costing exercise becomes more subjective.8 162.0 291.in this case the financial institution has measured the amount of time that is spent on each product. In practice this step takes time.0 25. or can be gathered relatively easily using a manual process. Normally different allocation bases are used for allocating the costs of front line staff and senior management.2 (28. In the example below.7 103. % Amt.5 5% 0. area is frequently used as the basis for allocating rental costs.0 0% 35% 40.0 Saving Loan Product Product % Amt. In this example the space that each product takes up within each branch is used as a proxy to determine how much of the rental income should be allocated to each product. so this is allocated 100% to the loan product.0) 75. this basis is called the Direct Basis. as each grade of staff needs to be considered separately. Quantifying Allocation Bases Information related to the allocation bases is gathered and then applied to the different products.0 100% 50.0 100. Where costs can be related specifically to a particular product. as per a/cs 316. . 0% 0.3 95% 5.8 20% 15. this will depend in part on what information about the exact nature of the expense incurred. and determined that 35% of staff time is spent on the savings product and 65% of time is spent on the loan product. this basis is called the Portfolio Basis.5 55% 5.0 10.8 Direct Staff Time Area Staff Time Transaction Actual Figure 3: Quantifying Allocation Bases Staff time is frequently used to allocate staff costs .OLA Interest income – Investments Transfer Pricing Adjustment TOTAL INCOME Interest expense Staff salaries etc.8 65% 16.0 266. Rent Motor vehicles Insurance Communications TOTAL EXPENSES Net Result Allocation Basis Direct Portfolio Amt. Allocation Unit Interest income .0 6.0 80% 60. but should be based on logical and defendable criteria.

Costly Bank would save only 10% of their total Salary Bill. .8 162.0 50.0 100% 35.0 266.Product Costing in Practice – The Experience of MicroSave-Africa 25 Making a Transfer Pricing Adjustment Financial institutions make money from accumulating the savings of their depositors and lending a proportion of these funds to their borrowers. Rent Motor vehicles Insurance Communications TOTAL EXPENSES Net Result Allocation Basis Direct Portfolio Amt.0 291. this is to say the cost at which an institution would have to borrow funds in order to finance their loan portfolio were deposits not being used.0 366. A transfer pricing adjustment reflects the fact that funds for lending have been generated by mobilizing deposits – the adjustment makes a notional interest charge against loan products and credits this to deposit products. This approach is appropriate either in markets where subsidised funds are available as in the case of many donor supported MFIs. % Amt.3 45% 4. Although Costly bank will be able to save the salary of a few cashiers. The costing is revised so only the element that can be saved is attributed to the savings product. two rates to consider are: The marginal rate at which an institution can borrow funds – This approach argues that the full opportunity cost of capital should be charged. Looking at each line of income and expenditure. and the 25 is credited back to the savings product. The notional interest is allocated back to savings products in proportion to their contribution to the source of funds. as per a/cs 316.0 100% 316.OLA Interest income – Investments Transfer Pricing Adjustment TOTAL INCOME Interest expense Staff salaries etc. such as Motor Vehicles costs and Insurance.0 10.3 95% 5.3 65% 74.0 (25.0 25.2 (28.0 75.0 115.0 35% 8. or where funds are rationed internally.0 100% 50. Assuming this has been done Costly Bank now has a dilemma. the loan product is “charged” 25 for the money it has effectively borrowed from depositors’ savings.0 100.0 80% 60.0) 75.0 0% 35% 40. The long-term investment rate – This approach argues that the long-term interest forgone on investing deposits longer term should be charged to loan products. Allocation Unit Interest income .7 103.0 Saving Loan Product Product % Amt.8 Direct Staff Time Area Staff Time Transaction Actual Figure 4: Transfer pricing adjustment The transfer price adjustment is calculated on the basis of the average outstanding loans whose funds have been sourced from deposits multiplied by a notional interest rate. The question becomes what rate of interest should be applied as a transfer price.0 35. Final Costing of Products After applying the allocation bases Costly Bank finds that the Savings Product is making a loss! The first step should be to review the allocation exercise to see if some mistakes have been made – and to reconsider some of the more subjective indicators. In this example.8 20% 15.0 0% 25.5 5% 0. what should it do? Marginal Costing One of the things that Costly Bank should consider is the contribution that the savings product makes towards covering the costs of the institution. the questions Costly Bank needs to ask are “What income would we forgo if we did not have the savings product?” and “What costs would we save if we did not have the savings product?” In this case.0 6.5 55% 5. management costs would largely remain the same.8 65% 16. 0% 0. It is the rate MicroSaveAfrica normally applies.8) 128.

0 266. Costly Bank would not make any savings on rent (at least in the short to medium term) if the savings product were closed down.0 10. as per a/cs 316.0 79.3 95% 5.0) 75.0 35.0 100.0 100% 316.1 212.Product Costing in Practice – The Experience of MicroSave-Africa 26 Looking at rent.0 0% 25.0 100% 35. In terms of Motor Vehicles.OLA Interest income – Investments Transfer Price Adjustment TOTAL INCOME Interest expense Staff salaries etc.1 Direct Core Fixed Core Core Actual Completing the exercise Costly Bank can see that although the savings product is losing money as a product.0 100% 50.5 5% 0. Rent Motor vehicles Insurance Communications TOTAL EXPENSES Net Result Allocation Basis Direct Portfolio Amt. but probably Costly Bank may still require the same number of vehicles. Allocation Unit Interest income .0 0% 10% 11.3 35% 3. some Motor Vehicle running costs would be saved.0 Saving Loan Product Product % Amt.0 291.0 (25.8 85% 21.0 366.5 0% 0.0 15% 3.5 90% 103. . % Amt.0 115. it should be kept on as a product in the short term because it is contributing 21 to the costs of the organisation as a whole.0 75.7 54.0 21.0 25. 0% 0.0 100% 75.5 65% 6.0 50.0 6.

Cashier checks on the voluntary savings on an “exception” basis verbally discussing the excess or shortfall remitted by the Member with the Member and the Credit Officer. Credit Officer sums the total cash deposited (net of withdrawals) as recorded in the Collection Register and agrees this to the total cash in hand. H6 Member hands cash (savings and loan instalments) to Group Cashier together with her Pass Book. Cashier checks if the amount included in the Pass Book is enough to cover loan repayment and compulsory savings. The Credit Officer records amount in the Pass Book and Collection Register. This shape identifies where a key document / cash is permanently located.An Example of a Process Audit Member Remittance of ASA – Group Meeting (Daily) Pass Book This shape indicates a process is happening This shape is used to indicate documents This refers to the user to another schedule where the collection register is next used Cash Collection Register 1 On completion of all transactions. A circle is used as a connector – look for the number again to show where the process continues Sample timings: 2 Minutes per book 1 minute per book Member’ s House A2 15 minutes 1 Passbook Collection Register Timings of processes have been added – enabling management to identify lengthy Cash The Credit Officer returns the Passbook for safe-keeping and takes Loan Register and cash to next meeting /Unit Office Cash is identified separately When the total net deposits and withdrawals agrees to the total cash in hand. Member Remittances – Unit Office (Daily) Collection Register Cash A1 . Cashier hands the Pass Book and cash to the Credit Officer.

Collection Register Daily Collection Sheet B4 2 1 Credit Officer updates Daily Collection Sheet Credit Officer counts cash and hands all of it to the Credit Officer acting as Cashier for the quarter. 10 minutes per group Sample Timings: 15 minutes per group 2 1 Collection Sheet Cash D3 CO Cashier counts cash and agrees it to the Collection Sheet All Credit Officers and Unit Manager sign. Sample Timings 10 minutes where correct 25 minutes where not correct C3 Bank Deposit Slip Cash CO Cashier prepares bank deposit slip (net of any necessary expenditures . 30 minutes on average .see Cash Expenses (Daily)) 3 minutes E3 Bank the By (rotated) assignment Unit Manager or Credit Officer takes cash to the bank and deposits it (or withdraws if additional cash required for loan disbursement and withdrawals).

abctech. Willliam et al. Robert Peck Christen. “It Can Work! A Toolkit for planning.centralbank.N.. Micheal J. Graham A.go. (www.cgap. conducting and monitoring pilot tests for MFIs”.References: Please Note: All of the MicroSave-Africa publications quoted here are available on the internet.com. “ABC Provides Unique Advantage at Standard Bank”. on www.org Bank of Tanzania: Statistics www. the CGAP Toolkit is available from www. Graham A.com/successes) Sinkey Joseph Jr.N.org Central Bank of Kenya: About Treasury Bills www. MicroSave-Africa (2001) .N. MacMillan (1992) Wright. Imran Matin ASA’s Culture. Competition and Choice: Introducing Savings Services into a Microcredit Institution.MicroSave-Africa.bot-tz. David. MicroSave-Africa (2001) MicroSave-Africa and Acclaim Africa (2001) “Costing of Financial Services” MicroSave-Africa and Acclaim Africa (2001) “Pricing of Financial Services” Putter. Peter Mukwana. Leonard Mutesasira. “Market Rearch and Client Responsive Product Development”. Graham A. MicroSave-Africa (2002) Helms. Brigit and Lorna Grace “CGAP Product Costing Tool (draft for comment)” CGAP (2001) McCord. Standard Bank of South Africa. “Commercial Bank Financial Management in the Financial Services Industry”. MicroSave-Africa (2001) Wright. Wright and Henry Sempangi “A Brief Review of the Action Research Programme (draft)”..ke Cracknell.

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