Allocation of costs, when done based on a cost and effect situation, can be an effective way to manage overhead costs.
Banks often use headcount or FTE as a common method of allocation.
More sophisticated banks may also consider the activities performed by departments like HR to allocate costs.
Knowing the normative time spent on activities can help managers allocate costs more accurately.
Welcome to ‘Decoding Cost & Performance,’ where we bridge the gap between financial transparency and actionable insights. Dive deep with industry frontrunners as we address tough questions in bite-sized moments spanning 3-5 minutes each. In this episode, we aim to equip finance professionals with the skills and knowledge they need to understand how banks distribute their costs.
The Beauty of Allocation
Some of us don’t like the word “allocate,” because it seems as if costs are being pushed through without a well-known cause and effect relationship. But I personally believe that allocate is a very beautiful word, as long as you use it in a way that allocating the cost is based on a cost and effect situation.
Overhead Costs: The Unseen Burden
In any organization, whether it’s a bank or a cookie factory, there is overhead cost. There is internal cost going through, there is an IT department, there is management, there are things going on that are not really easy to directly attribute to the end product. These costs need to be somehow allocated out to be able to land them on the end product because you want to have a fully loaded cost price for your end product.
The Art of Allocation in Banks
Banks usually look at the type of cost that we’re talking about, which can be classified as overhead costs. For example, consider your HR department. You cannot directly attribute HR to a mortgage or a credit card or a consumer lending product. So, having that classified as overhead, the only thing you need to do is to figure out what is a correct driver to allocate the cost out so that it eventually lands on the product.
The Role of Headcount
One common method of allocation is based upon headcount or full-time equivalent numbers (FTE). This is a cause and effect relationship because every department that is doing direct activities, say for example the front office or the back office in a bank, they will have a number of headcount and the number of headcount pretty much drives the activity of the HR department.
Moving Beyond Simple Drivers
Some banks go a little bit more sophisticated. They say, okay, but I do not only have a simple driver as headcount or FTE. I know the activities that are being done in my HR department. And if you would know for the departments that are actually being serviced by HR: the numbers of the growth plans, the number of new contracts, the number of dismissals. Then you get a more granular cause and effect relationship of the HR cost.
The Importance of Normative Time
A good manager knows pretty much what his personnel is doing. An excellent manager, however, knows the normative time that is being spent on setting up a new contract. So he knows a new contract is usually 7 hours, 12 new contracts is 7 times 12, that’s the amount of hours that is needed. This normative time allows you to calculate the other way around and say: okay, if there’s 12 new contracts in my back office, then I expect to need 84 hours from my HR personnel that are involved in setting up the new contracts.