Accounting and Finance Foundations

Unit 11

Accounting and Finance Foundations Unit 11: Financial Analysis 863

Financial Analysis

Chapter 25

Student Guide

Lesson 25.1 Productivity

Technological advancements and improvements such as faster computers and better software are assets

that allow people to perform tasks in a more productive manner. To be successful, companies need to

assess how well they use resources as well as what improvements could be made to be more productive.

Productivity encompasses two different elements—efficiency and effectiveness. To maximize profits, com-

panies must be both efficient and effective.

Efficiency measures how well a company uses its resources (inputs). Efficiency is measured by comparing

the actual inputs to the expected inputs. Inputs include material and time required to make a product.

For example, if a shirt can be made with just one yard of material but Employee A typically uses three yards

to make the same shirt, that employee is considered inefficient or wasteful. Someone or something is

inefficient if the actual number of inputs exceeds the expected number (actual inputs > expected inputs).

On the other hand, an efficient employee’s actual inputs are less than expected (actual inputs < expected

inputs).

Effectiveness is a measure of how well the final product (output) is made. To determine effectiveness, you

must compare how well a product is actually made with how well the product should have been made.

An employee is considered to be effective if the employee can produce the desired amount of product in

a specific time. An employee is ineffective if the employee either does not produce enough products in a

given time or if the products produced do not meet minimum standards.

For example, if managers expect an employee to make four products a day (all of which meet specified

standards) but an employee only makes three, that employee is considered ineffective—even if the prod-

ucts meet standards. Likewise, if an employee makes six products but none of them meet the standards,

that employee is also considered ineffective.

One way to measure productivity is through the use of a quality-control inspector. The inspector checks

an item for damage and determines if the specifications for that product are met. Many companies allow

for minor mistakes—since everyone makes a mistake every once in a while—but to keep the company

running effectively, checks and balances must be in place. Inspectors use the following formula to calcu-

late effectiveness:

Percent Defective = Number Defective / Total Number Checked

Individual companies determine what they see as an appropriate percentage of defective products, but a

common standard is five percent.

Example: If an employee can make 300 products in a day and six of those are considered defective, is that

employee considered effective or ineffective? (The company allows for a five-percent defective rate.)

Solution:

Percent Defective = Number Defective / Total Number Checked

= 6 / 300

= 2%

Since the employee’s defective rate of two percent is less than the company’s expected rate of

defective products, that employee is considered effective.