For every small business, efficiency matters. Getting more – more units produced, more sales, more revenue – for less – less waste, less labor, less cost – is every business leader's dream. However, far too many business owners focus on increasing revenue rather than identifying ways to make their businesses operate efficiently. In the business world, where income equals revenue minus expenses, this could be a big mistake.
Importance of Production Efficiency
Efficiency is an important measure of a company's performance. Unlike productivity, which a company achieves by maximizing the number of units produced in a given time frame, efficiency requires the minimization of costs and the maximization profits for a given level of output. Efficiency, therefore, enables a business to make the best possible use of the company's resources. For example, an efficient company will produce a greater number of quality products, with less waste, using less energy and other resources during a given period than an inefficient company.
Efficiency and Performance Measurement
Efficiency is measured by dividing a worker's actual output rate by the standard output rate and multiplying the outcome by 100 percent. The standard output rate is a worker's normal rate of performance or the volume of work a trained employee can produce per unit of time using a prescribed method and with the usual effort and skills. As production efficiency increases, production costs go down. The operations strategy, technology, job design and process influence the rate of output as does the worker's skill and effort.
Example of Efficiency Measurement
Assume that Watkins Painting has determined that the standard time required to prepare, prime and paint one average-sized room is three days, or 24 hours, equal to painting approximately 4 percent of the room per hour. Assume that Watkins charges $400 per room for labor, that he bills separately for materials and that he pays the painter $10 per hour. Watkins’ production efficiency rate equals one room divided by 26 actual hours or .038 actual output rate, which is divided by one room divided by 24 standard hours or .042 standard output rate, which equals .90. Next, .90 is multiplied by 100 percent, which equals 90 percent efficiency.
To determine actual Watkins’ profit or loss, multiply the $10 painter's hourly rate by 26 hours to equal $260 actual labor costs. Subtract this number from the $400 per room fee, which equals $140. Watkins’ profit is equal to $140, which is $20 less than the $160 the company would have earned if the painter had been more efficient.
Standard Efficiency Rates
A small business can use a time study to determine the average time required to perform specific tasks. These averages then become future performance targets. To conduct the time study, the times required for multiple employees to complete a task are recorded and the average completion time is calculated. This average time becomes the standard or benchmark for the activity.
Using such standards, the business can evaluate employees’ actual production efficiency for a number of purposes. For example, production efficiency rates can serve as a basis for bonuses and merit raises. The efficiency rates can also identify opportunities for improvement in a production line or serve as input for operational planning and control.
