Question
Royal Financial Services (RFS) provides front end loan origination services for a number of banks who process and maintain loan portfolios. RFS accepts applications from
Royal Financial Services (RFS) provides front end loan origination services for a number of banks who process and maintain loan portfolios. RFS accepts applications from customers and processes them through closing of the loan agreement before turning the loan over to customer banks. RFS is paid regardless of whether the loan closes or not. RFS currently services three types of loans - residential mortgages, auto loans, and personal unsecured loans. RFS has no cost accounting system so total operating expenses are simply allocated to each product line based on revenue. RFS management is concerned about the overall low profitability of the business and has asked you to apply activity-based analysis in order to give RFS a better understanding of relative product profitability. You determine that the application processing and loan analysis activities are performed using internal RFS resources while the credit and closing activities are performed primarily by external credit agencies and law offices on a per transaction basis (e.g. $X per credit check, $Y per closing hour). You also learn 70% of the mortgages end up being closed (the remainder are not approved after loan analysis); 80% of auto loans close and 90% of personal loans close. You also identify a key external measure of how well RFS is performing versus the industry. While RFS does not bear the cost of defaults, their customers do track RFS performance and use it to negotiate future origination fee rates.
Revised ABC Income Statement | Mortgage | Auto | Personal | |
Total Revenues | $ 525,000 | $ 1,200,000 | $ 460,000 | |
Operating Expense | Accept applications | 308000 | 231000 | 77000 |
Obtain credit referrals | 133000 | 133000 | 66500 | |
Do loan analysis | 328000 | 218667 | 109333 | |
Close loan | 283371 | 141686 | 70843 | |
Total Oper Exp | 1052371 | 724352 | 323676 | |
Profit | -527371 | 475648 | 136324 | |
Profit % Revenue | -100.5% | 39.6% | 29.6% | |
Mortgage | Auto | Personal | ||
Default rate experienced by loan processor | 2% | 1% | 6% | |
Industry average | 2% | 3% | 4% | |
Per Unit | Mortgage | Auto | Personal | |
Total Revenues | $ 175,000 | $ 1,200,000 | $ 460,000 | |
Operating Expense | Accept applications | $ 102,667 | $ 77,000 | $ 25,667 |
Obtain credit referrals | $ 44,333 | $ 44,333 | $ 22,167 | |
Do loan analysis | $ 109,333 | $ 72,889 | $ 36,444 | |
Close loan | $ 94,457 | $ 47,229 | $ 23,614 | |
Total Oper Exp | $ 431,333 | $ 241,451 | $ 107,892 | |
Profit | $ (256,333) | $ 958,549 | $ 352,108 |
Summarize and Make specific recommendations to RFS to improve business profitability.
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