An efficiency factor is a specific calculation that businesses use to compare the estimated hour of an activity compared to the actual hours needed to complete the job. In many ways, this may be more of an economic measurement or ratio than a standard business or accounting figure. It is common for companies to compute standard hours to complete a job as this is the measuring stick for employee output. All activities face comparison to this efficiency factor, with hopes that each activity at least meets or exceeds it. Different factors are usually common for different activities in a company.
In most cases, there is no single method used to compute an efficiency factor. Business analysts, operational managers, or managerial accountants may all play roles in gathering data for putting together the factor. For example, the production department is often under intense scrutiny for efficiency. Individuals in the business review all areas relating to the production of a single unit. Then, a standard hour for completing a single unit under perfect conditions is the result of computations relating to the efficiency factor.
A company does not expect perfect conditions in its production activities, so an efficiency factor may also be created for what the business considers normal conditions. In most cases, this factor will not match the factor under perfect conditions. The factor under normal conditions most likely is longer as the analysts computing the figure must take into account different production conditions. For example, inferior raw materials may result in more refinement, which increases the time it takes to produce a single unit. The standard hour for completing a single unit will be negatively affected due to this and other potential flaws or problems in the production system.
Another use for an efficiency factor is to apply it to manufacturing overhead costs. These overhead costs apply to all units produced in a given manufacturing system, not a single good or batch produced at one time. A flexible budget presents an estimate of the overhead costs for a per-unit basis, with the standard hour — or efficiency factor — the primary tool for applying these costs. Though the result is most likely imperfect, it does give the company a close estimate for per-unit costs. Using the actual standard hour and then adjusting the difference through the cost of goods sold account is a common activity when using this method.