By Steve Wofford
Many financial institutions are making strategic decisions with profitability systems that look sophisticated, sound credible, and are still fundamentally wrong. That is not a reporting nuisance. It is a strategic problem.
The flaw usually begins at the foundation. Most profitability systems start with internal accounting structures instead of customer behavior. They decide in advance how costs will be spread across departments, balances, or account counts, then work backward to produce product profitability. But that is not how costs are created in a financial institution. Costs begin when customers choose products, choose channels, and generate servicing demands. Those choices create work. The work consumes time. The time creates cost. When a profitability system ignores that chain of cause and effect, it substitutes accounting convenience for economic reality.
Why it Matters
A quick look at almost any income statement shows why this matters. People costs commonly account for around half of total non-interest expense, and much of the rest exists to support the people doing the work. So, when an institution gets the attribution of labor wrong, it is not making a small technical mistake. It is misplacing the largest operating cost category on the income statement. Once that happens, the entire profitability system becomes suspect.
That is exactly why Time-Driven Activity-Based Costing is so valuable. TDABC starts with what people actually do, how long it actually takes, and which products, channels, and customer behaviors actually consume institutional resources. It does not assume that balances or account counts are reliable stand-ins for labor intensity. It follows the work. And if a profitability system does not follow the work, management should be cautious about trusting the answer.
Going Off the Rails
This is where many commercial and homegrown systems go off the rails. They rely on proxy allocations because proxies are easy. A balance-based allocation looks neat. A loan-count allocation looks reasonable. But neither necessarily reflects what employees are actually spending their time doing. The result is that the same product can look attractive under one method and destructive under another. That is not insight. That is distortion.
But even accurate operating cost attribution is only part of the story. A profitability system can still fail badly if it ignores Funds Transfer Pricing.
Failing to use FTP is a serious problem because FTP separates product performance from the effects of interest rates, liquidity posture, and enterprise funding decisions. Without FTP, institutions often confuse market conditions with manager performance and product economics with balance-sheet structure. A loan portfolio can appear more profitable than it really is because it is benefiting from a funding advantage created elsewhere. A deposit product can appear less valuable than it really is because the funding value it provides is never properly credited. Without FTP, product profitability becomes contaminated by treasury outcomes and accounting convention.
A Dangerous Distortion
That distortion is dangerous. It leads institutions to reward the wrong behaviors, misprice products, and misunderstand where value is actually being created. Loan teams can appear stronger than they are. Deposit franchises can appear weaker than they are. Executives can think they are comparing product performance when they are really looking at a muddled blend of product behavior, market timing, funding mix, and flawed allocations.
In other words, without FTP, product profitability is not really product profitability.
And when a financial institution ignores both TDABC and FTP, the errors compound. One side of the equation misstates operating cost because it does not measure the real work being performed. The other side misstates financial contribution because it does not assign the true value and cost of funds. At that point, the institution is not managing profitability. It is managing illusions.
The Stakes are High
This is why the stakes are so high. Profitability analytics shape pricing, growth strategy, staffing priorities, product focus, channel investment, and executive decision-making. If the economics underneath them are wrong, strategy will be wrong too. Institutions may expand products that destroy value, retreat from products that create it, and reward outcomes that look good only because the math behind them is flawed.
The answer is not a prettier dashboard or a more elaborate allocation table. The answer is a profitability framework built on economic cause and effect. That means tracing operating costs through actual activities and time consumption. It means using FTP so each product is credited or charged for the funds it truly uses or provides. It means refusing to accept internal accounting shortcuts as a substitute for strategic truth.
That is the question every executive team should be asking: does our profitability system reflect economic reality, or just institutional habit?
Because if it is built on shortcuts, the problem is not that the numbers are imperfect. The problem is that they may be confidently wrong.
Steve Wofford is CEO of Kohl Analytics Group.
