Measures of Productivity [PDF]

Measures of Productivity – The Value Added Concept. 1. Dr Philip ... Value added is a term that has been used in manag

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Dr Philip E Dunn FAAI MCMI Chartered MCIPD FCIB(Hon) Cert Ed (Leeds) Measures of Productivity – The Value Added Concept There is much focus on performance and productivity, but how can this be measured? It is recognised by many that the most meaningful measure of productivity uses the concept of value added. Value added is a term that has been used in managerial accounting for over five decades. I first became aware of the concept, when as a trainee accountant in the 1960’s, I read an article by Ronald Giltrist of Urwick Orr and Partners and he defined value added as “The value of sales less the cost of all bought out items.” “It constitutes the fund which a company applies to: • • • •

pay employees pay providers of capital pay government taxation; and maintain and expand assets”

The use of value added as the basis of performance indicators has been under the spotlight in recent times with the publication by the DTI of the Value Added Scoreboard that provides measures of wealth of some 800 UK companies and the top 700 EU companies by value added. The Scoreboard was first published in 2002 (the 2009 publication is available from the Department for Innovation Universities and Skills) It is recognised that to sustain sound performance Britain needs to continue making a transition to being an open, globally integrated “knowledge economy” in manufacturing and services. Value Added measures the wealth a company creates not just for itself but also for its shareholders and society as a whole. The scoreboard shows that UK’s largest companies are on average much more efficient creators of Value Added than their European peers. Value Added analyses how efficiently companies use their staff and assets to create wealth. Before I consider the performance indicators (ratios) that use VA as a base I wish to outline further the meaning of value added. The following is an extract of the Profit and Loss Account of Whitby Engineering Ltd; together with additional information.

Measures of Productivity – The Value Added Concept

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Profit and Loss Account For Year Ended 31 December 2009 Turnover Cost of Sales * Profit before interest and tax Finance Cost (interest) Profit before Tax Taxation Profit after tax Dividends ** Retained profit * Cost of Sales comprise: Wages, salaries and other employee benefits Depreciation Bought out items

£000’s 8500 6200 2300 600 1700 400 1300 250 1050 £000’s 2050 550 3600 6200

Number of employees 150 **

Dividends are not normally shown at the foot of the Profit and Loss Account but is done so here for reference only.

From this information we can re-state the Profit and Loss Account in the form of a statement of value added. Value Added Statement Year Ended 31 December 2009 £000’s 8500 3600 4900

Turnover Less bought out materials and services Value added Applied as follows: To pay employee wages, salaries and other benefits To pay providers of capital: Interest Dividends To pay government corporation tax To maintenance and expansion of assets: Depreciation Retained profit Value added

Measures of Productivity – The Value Added Concept

2050 600 250 850 400 550 1050

1600 4900

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The DTI Scoreboard uses a number of valued added ratios two of which are featured below. • •

Value added per employee Value added per ‘£’ of employee cost

From our figures for Whitby Engineering we find: Value added per employee: Value Added Number of Employees £4.9m 150 £32667 per employee Value added per ‘£’ of employee costs: Value Added Employee Wages Salaries and other Benefits £4.9m £2.05m 2.39 (number of times) Both these performance indicators (ratios) measure employee productivity and could be used in an inter-firm comparison and a comparison to a benchmark for the industry as a whole. Also a year on year comparison for Whitby would be most useful to establish the trend on this important measure that is an excellent guide to company performance.

Measures of Productivity – The Value Added Concept

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