Productivity is a term used to indicate improved efficiency which results in more output for the same input.
When to Use Productivity
Productivity measures are used when companies are in a cost-cutting mode. Productivity can be applied to the entire business cost structure or it can be focused on a particular type of cost, such as variable cost.
Productivity is a term that is used frequently in business to indicate improved efficiencies. Within the finance community there is a specific way to calculate productivity. This productivity calculation removes the effects of inflation and deflation. It focuses on whether the organization was able to do more output with the same input. (or same output with less input). This calculation focuses on the output for a given amount of resources.
- The productivity ratio calculation starts with an output ration that is sales divided by costs. At the business level, this is all of the sales for product and services (remove unusual items from the revenue) and all of business costs for some time period.
- The change in productivity is determined by calculating the change in ratios from year to year. Positive productivity has occurred if that ratio is larger than the previous year. Negative productivity occurred if the ratio is smaller than the previous year.
- While the productivity ratio calculation at a business level includes all costs, a variation that is often calculated will only use the variable costs. When the ratio is calculated in that manner, it is known as Variable Cost Productivity.
- Because the calculation are comparing year to year, a factor is used to adjust for inflation or deflation.
- Therefore if your product used oil, you wouldn’t automatically be credited for positive productivity when the price of oil dropped and negative productivity when it went up. To get positive productivity, you would need to reduce the amount of oil used. That is reduce the amount of resource required.
- Finance will provide the factor based upon their analysis. They may have different factors for different commodities or categories of sales and costs.
- The calculation is a three step process:
- Adjust current year sales and cost information back to last year’s standards. Adjust for price inflation and deflation.
- Determine the ratio of sale/cost for last year and the current year – using the adjusted values.
- Calculate the percentage change in the ratio.
- Many companies calculate this monthly using a rolling 12 month window (i.e. the most recent 12 months, regardless of which fiscal year the month was in.)
Hints and Tips
- This is not the same as cost increases or cost savings due to price adjustments either with customers or suppliers. Those effects are removed from this analysis but do affect the financial reports and statements.
- The analysis is done in this manner to evaluate managers and determine if they were actually more efficient or just lucky. Generally, the operational managers cannot control pricing, but they can control usage, scrap, and other factors that add cost.
- Note that a cost reduction would provide positive productivity using this measure only in the year when it went into effect. After that, the effect is already in the numbers from the previous year, so there would be no further improvement in the productivity ratio, although the cost savings would continue year after year. Therefore to get positive productivity, changes must be made every year to reduce the utilization of resources.
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