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what is pro forma | pro forma means for the sake of form or as a matter of form when it appears in financial statements it indicates that a method of calculating financial results using certain projections or presumptions has been used pro forma financials are not computed using generally accepted accounting principles gaap and usually leave out one time expenses that are not part of normal company operations such as restructuring costs following a merger essentially a pro forma financial statement can exclude anything a company believes obscures the accuracy of its financial outlook and can be a useful piece of information to help assess a company s future prospects investopedia matthew collins | |
what are the types of pro forma financial statements | pro forma financial statements are projections of future expenses and revenues based on a company s past experience and future plans some standard pro forma statements include the following a budget anticipates the inflow of projected revenues and the outflow of funds for a defined future period usually a fiscal year a budget is based on certain assumptions about future expenses and revenues it takes into account past expenses and revenues and factors in the costs of the company s plans for the fiscal year a pro forma income statement uses the pro forma calculation method mainly to draw the attention of potential investors to specific numbers when a company issues its quarterly earnings announcement for example a company will report its actual sales and expenses for the quarter that just passed and in the same chart will list its projections of these numbers for the current quarter in this case the company is projecting the future based on its knowledge of past sales and expenses and factoring in expected changes a company may present a pro forma statement to inform investors about their internal assessment of the financial outcome of a proposed change in the business for example if a company is considering an acquisition or a merger it may publish a pro forma statement of the expected impact of the move on its future earnings and expenses in financial accounting a pro forma earnings report excludes unusual or nonrecurring transactions these excluded expenses could include declining investment values restructuring costs and adjustments made on the company s balance sheet that fix accounting errors from prior years accountants prepare financial statements in the pro forma method ahead of a proposed transaction such as an acquisition merger a change in a company s capital structure or new capital investment these are models that forecast the expected result of the proposed transaction they focus on estimated net revenues cash flows and taxes the statements are presented to the company s management to help it make a decision on a proposed action based on its potential benefits and costs limitations of pro forma statementsinvestors should be aware that a company s pro forma financial statements can hold figures or calculations that do not comply with gaap which is the set of standards followed by public companies for their financial statements 1in fact they can differ vastly pro forma results may contain adjustments to gaap numbers in order to highlight important aspects of the company s operating performance pro forma financials in the united states boomed in the late 1990s when dot com companies used the method to make losses appear like profits or at a minimum to reveal much greater gains than indicated through u s gaap accounting methods 2the u s securities and exchange commission sec responded by cautioning that publicly traded companies report and make public u s gaap based financial results as well the sec also clarified that it would deem using pro forma results to grossly misconstrue gaap based results and mislead investors fraudulent and punishable by law 1using pro forma results to grossly misconstrue gaap based results and mislead investors is deemed by the u s securities and exchange commission sec to be fraudulent and punishable by law 1 | |
how to create a pro forma statement | basic templates for creating pro forma statements can be found online or they can be created using a microsoft excel spreadsheet to automatically populate and calculate the correct entries based on your inputs you can also create a pro forma financial statement by hand the steps are here s a historical example of a pro forma income statement courtesy of tesla inc s tsla unaudited pro forma condensed and consolidated income statement for the year ended dec 31 2016 | |
what is a pro forma financial statement | pro forma financial statements incorporate hypothetical numbers or estimates they are built into the data to give a picture of a company s profits if certain nonrecurring items are excluded these are often intended to be preliminary or illustrative financials that do not follow standard accounting practices companies use their own discretion in calculating pro forma earnings including or excluding items depending on what they feel reflects the company s true performance or future performance as pro forma forecasts are hypothetical in nature they can deviate from actual results sometimes significantly | |
what s the difference between pro forma and gaap financials | there are no universal rules that companies must follow when reporting pro forma earnings this is why it is important for investors to distinguish between pro forma earnings and those reported using generally accepted accounting principles gaap gaap enforces strict guidelines when companies report earnings while pro forma figures are better thought of as hypothetical earnings for this reason investors must examine not only the pro forma earnings but also gaap earnings and never mistake one for the other | |
what is a pro forma invoice | a pro forma invoice is a preliminary bill of sale sent to a buyer in advance of a shipment or delivery of goods the invoice will typically describe the purchased items and other important information such as the shipping weight and transport charges a pro forma invoice requires only enough information to allow customs officials to determine the duties needed from a general examination of the included goods can you compare pro forma statements from different companies maybe but it is not advised companies definitions of pro forma vary along with their internal methods for forecasting and making assumptions if you don t know how each of the companies defines its pro forma figures you may be comparing apples to oranges the bottom line | |
when it comes to investing pro forma latin for as a matter of form or for the sake of form generally refers to the manipulation or forecasting of financial results pro forma allows companies to exclude certain expenses and gains from their published gaap numbers and offer projections of future performance | this can be useful for management and investors but also in some cases misleading to the untrained eye companies try to present themselves in the best way possible in financial statements to attract more investment and this can mean directing attention to pro forma numbers that paint it in a better light | |
what is a pro forma invoice | a pro forma invoice is actually not an invoice it is a preliminary bill of sale sent to buyers when an order is placed and in advance of a shipment or delivery of goods it will typically describe the purchased items price and other important information such as the shipping weight and transport charges understanding pro forma invoicesa pro forma invoice is different from a simple price quotation in that it lays out the terms of a transaction however the terms are subject to change it represents a good faith estimate that s used to inform the buyer and prevent misunderstandings about any unexpected or significant charges once the transaction is final businesses in virtually all industries use pro forma invoices to satisfy their internal purchase approval process pro forma invoices streamline the sales process by limiting additional back and forth after a transaction is intiated as all terms have been defined upfront most pro forma invoices provide the buyer with a precise sale price they include an estimate of any commissions or fees such as applicable taxes and shipping costs a firm may send a pro forma invoice before shipping any agreed upon deliverables or with the shipped items it contains cost details associated with the sale but is not an official demand for payment no guidelines dictate the exact presentation or format of a pro forma invoice and it may or may not resemble actual commercial invoices 1pro forma invoices often come into play with international transactions especially for customs purposes relating to duties on imports purpose of a pro forma invoicea pro forma invoice is used by a seller to communicate to a buyer the expected costs fees and date of delivery for an order this transparency can help the manufacturer avoid any misunderstandings when the order is delivered the pro forma invoice represents an estimate of the costs that the buying party should expect to pay a pro forma invoice also provides the buyer with an opportunity to negotiate the terms before delivery for example if the buyer is not satisfied with the price quantity or delivery timeline they can contact the manufacturer to reach a mutually satisfactory conclusion pro forma invoices aren t legally required but they re generally a good idea because they can prevent disputes at the time of delivery 2pro forma informationspecific documentation is required before goods can pass through customs into the u s a traditional commercial invoice must list substantial information such as the buyer and the seller a description of the goods the quantity the value for all the shipped items and the location of the purchase the method of payment currency carrier and more 3a pro forma invoice isn t needed for international shipments but is often used when a transaction that isn t final requires an estimate of the cost of products being bought it should include enough information to allow customs to determine the duties needed from a general examination of the included goods this information can include 3if a firm uses a pro forma invoice for customs it must also present a commercial invoice within 120 days 4a pro forma invoice should include all the details of a transaction even if certain figures aren t yet final so that nothing comes as a surprise to the buyer depending on the type of business a pro forma invoice can include pro forma means for the sake of form it s used to announce that the information within a document is based on projections and isn t final 2pro forma invoice vs final invoicewhile a pro forma invoice represents a preliminary notification of the terms of a purchase agreement a formal final invoice is an official commercial instrument that informs the receiving party of their payment obligation a formal invoice is usually issued at the time of delivery and constitutes a request for payment by the receiving party unlike an official invoice a pro forma invoice is simply used to prevent misunderstandings about the specifics of a transaction such as the amount due it is usually issued at the time an order is placed so that the buyer can clarify any questions about the price or date of delivery 5pro forma invoice examplea firm may use a pro forma invoice if the terms of the sales contract specify that full payment is not due until the buyer receives certain goods for example a bakery customer might agree to the price of a cake on a pro forma invoice and the baker will deliver the cake once it is ready the customer will then pay for it when they receive the final formal invoice the final invoice amount should be the same or close to the amount on the pro forma invoice | |
what is in a pro forma invoice | most pro forma invoices provide the buyer with a product description selling price and an estimate of any commissions or fees although the pro forma invoice may be subject to change it provides all transaction details so that no charges come as a surprise once the transaction is final | |
how does a commercial invoice differ from a pro forma invoice | a traditional commercial invoice for international shipments must list substantial information such as the buyer and the seller a description of the goods the quantity the value for all the shipped items the location of the purchase currency mode of transport payment terms and method of payment a pro forma invoice requires only enough information to allow customs to determine the duties on the shipment from a general examination of the included goods can a seller cancel a pro forma invoice it doesn t need to be a pro forma invoice is simply a description of an impending transaction based on an order placed by the buyer it isn t an actual request for payment it confirms certain details and makes it clear that others are yet to be confirmed the bottom linea pro forma invoice is a preliminary document that outlines the terms of sale when an order is placed although it is not final a pro forma invoice should give the buyer a clear understanding of the terms of sale including the price date of delivery and any additional fees it is less official than a formal final invoice which is typically issued at the time of delivery | |
what is pro rata | pro rata is a latin term used to describe a proportionate allocation it translates to in proportion it s a process in which an allocated asset will be distributed in equal portions an amount is assigned to one person according to their share of the whole if something is distributed to several people on a pro rata basis a pro rata calculation can be used to determine the appropriate portions of any given whole but it s often used in business finance investopedia matthew collinsunderstanding pro ratapro rata typically means that each party or person receives their fair share in proportion to the whole pro rata calculations can be used in many areas including determining dividend payments these are cash payments by corporations made to shareholders pro rata in the insurance industry is used to determine the amount of premium due for a policy that only covers a partial term allocating the appropriate portion of an annual interest rate to a shorter time frame can also be done via pro rata pro rata is also used to determine how much of a distribution from a qualified retirement account such as an ira sep or 401 k is taxable when the account contains before and after tax dollars 1 an account holder might have a 401 k funded with 20 pre tax dollars and 80 post tax dollars withdrawals will consist of 20 taxable and 80 non taxable money as a result | |
how to calculate pro rata | pro rata is calculated based on three factors pro rata share number of true items maximum quantity possible pro rata distribution pro rata share quantity of related itemimagine an employee is set to receive a 10 000 bonus this year they ll receive a pro rata share of the bonus if they leave at any point the employee leaves on march 20th the agreement awards the bonus based on the number of days worked inclusive of the last day divide the number of true items by the maximum quantity possible to calculate the pro rata share the number of true items is the number of days worked there are 79 days inclusive between january 1 and march 20 assuming it s not a leap year the maximum number of days possible is 365 pro rata share 79 365 21 64 multiply the pro rata share by the related item to calculate the pro rata portion the item we want to pro rate is the annual bonus in this case pro rata distribution 21 64 10 000 2 164the employee will therefore receive a pro rata distribution of 2 164 by leaving on march 20 based on the prorated number of days worked of the year pro rata can be communicated as a percent such as the shareholder owns 10 of the company s stock or as a quantity such as the shareholder owns 100 000 of the company s 1 million shares | |
why pro rata works | the mathematical concept of pro rata works because the proportion of one good is imposed on another pro rata entails taking a fraction of one item and conveying the same fraction on another base the root of pro rata is grounded in proportionally equal fractions with different denominators the 79 365 fraction in our example is equal to the 2 164 10 000 fraction ignoring rounding variances pro rata is therefore simply taking one fraction and finding its equal given a specific denominator pro rata attempts to solve for the numerator to make two fractions equal given specific criteria consider another example where you and a friend want to proportionally share four pieces of pizza each of you would receive 50 of the pizza if the slices were shared equally this pro rata example is trying to determine which fraction with a denominator of four is equal to 1 2 each of you gets two slices because 2 4 1 2 examples of pro rataeach investor is paid according to their holdings when a company pays dividends to its shareholders the total amount of dividends paid would be 200 if a company has 100 shares outstanding and issues a dividend of 2 per share the total dividend payments can t exceed this limit no matter how many shareholders there are the pro rata calculation must be used to determine the appropriate portion of that 200 whole due to each shareholder assume there are only four shareholders they hold 50 25 15 and 10 shares respectively the amount due to each shareholder is their pro rata share this is calculated by dividing the ownership of each person by the total number of shares and then multiplying the resulting fraction by the total amount of the dividend payment the majority shareholder s portion is therefore 50 100 x 200 100 this makes sense because the shareholder owns half the shares and receives half the total dividends the remaining shareholders get 50 30 and 20 respectively be mindful of situations where weight isn t given to individuals every american citizen eligible to vote can cast a tally equal to every other citizen regardless of their age income or any other factor the pro rata value of the vote is equal to one divided by the total population that votes in this example another common use is to determine the amount due for a partial insurance policy term most insurance policies are based on a 12 month period so the insurance company must prorate the annual premium to determine what s owed if a policy is needed for a shorter term 2 divide the total premium by the number of days in a standard term and multiply by the number of days covered by the truncated policy to do this assume an auto policy that typically covers a full year carries a premium of 1 000 the company must reduce the premium accordingly if the insured only requires the policy for 270 days the pro rata premium due for this period is 1 000 365 x 270 739 73 pro rata calculations are also used to determine the amount of interest that will be earned on an investment the pro rata amount earned for a shorter period is calculated by dividing the total amount of interest by the number of months in a year and multiplying by the number of months in the truncated period if an investment earns an annual interest rate the amount of interest earned in two months on an investment that yields 10 interest each year is 10 12 x 2 1 67 payment on accrued interest on bonds is calculated on a pro rata basis accrued interest is the total interest that has accumulated on a bond since its last coupon payment the bondholder is still entitled to the interest that accrues up until the time the bond is sold if they sell the bond before the next coupon date the bond buyer not the issuer is responsible for paying the bond seller the accrued interest which is added to the market price the formula for accrued interest is as follows ai face value of bond coupon rate time factorwhere ai accrued interestcoupon rate annual coupon ratenumber of periods per yeartime factor days lapsed since last paymentdays in payment period begin aligned text ai text face value of bond times text coupon rate times text time factor textbf where text ai text accrued interest text coupon rate frac text annual coupon rate text number of periods per year text time factor frac text days lapsed since last payment text days in payment period end aligned ai face value of bond coupon rate time factorwhere ai accrued interestcoupon rate number of periods per yearannual coupon rate time factor days in payment perioddays lapsed since last payment the factor is calculated by dividing the length of time the bond was held after the last coupon payment by the time from one coupon payment to the next 3consider a bondholder who sells their corporate bond on june 30 the bond has a face value of 1 000 and a 5 coupon rate that pays semiannually on march 1 and sept 1 the buyer of the bond will pay the seller 1 000 5 2 122184 16 58 begin aligned 1 000 times frac 5 2 times frac 122 184 16 58 end aligned 1 000 25 184122 16 58 | |
what does pro rata mean | pro rata is a defined portion relative to the entirety of an item someone can get a pro rata share or a proportional offering based on how much they are entitled to instead of receiving all the items you may expect a pro rata share of 10 of the building s rental income if you own 10 of a building | |
what is the difference between prorated and pro rata | pro rata and prorated are used interchangeably to define the same thing both signify that a specific section of any given whole unit has a defined allocation for an underlying reason | |
how do i calculate pro rata | calculating the pro rata of items varies because it calculates a proportion of a given whole consider a company that charges 20 interest per year the prorated interest rate would be calculated as 20 12 x 6 10 if you calculated it over six months | |
how does pro rata apply to dividends per share | it s typically executed on a pro rata basis when a company distributes dividends consider a majority shareholder such as a founder or key executive who owns 50 of a company s total 1 000 shares the company is issuing a 1 dividend the majority shareholder would receive 500 in value of the 1 000 in dividends the formula would be as follows 50 100 x 1 000 500 | |
what is a pro rata discount | a pro rata discount is a type of discount a merchant offers a customer companies offer customers discounts for a variety of reasons they might offer one as an incentive to a new customer to try a product or service they might offer a discount if the customer makes a purchase during a specific time or as a bonus to a returning customer the pro rata part of the discount varies depending on how the merchant has structured their offer a merchant might offer a new customer 20 off their first purchase of products if they spend 100 or more each item would receive a 5 discount if the customer buys four products a pro rata discount could also apply if a customer joins a monthly subscription service on any day other than the first of the month the merchant would apply a pro rata discount and only charge the customer for the number of days in the month they had the service rather than charging the full subscription price for the month the bottom linepro rata translates to in proportion in latin each entity or individual is entitled to a share of a whole that s equal to their ownership percentage it s a common concept in business finance and investing dividends are awarded to investors based on the proportion of their investment to the whole a shareholder who owns 100 000 of a company s 1 million outstanding shares owns 10 of the company s outstanding stock and is therefore entitled to a pro rata portion commensurate with 10 of dividends paid | |
what is a probability density function pdf | the probability density function pdf is a statistical expression that defines the probability that some outcome will occur in this function the probability is the percentage of a dataset s distribution that falls between two criteria pdf is used by financial analysts to understand how returns are distributed in order to evaluate the risk and expectations of investment prices and returns understanding probability density functions pdfs the probability density function is a measurement of how often investment returns fall within a specified range pdfs are typically depicted on a graph with a normal bell curve indicating neutral market risk and a skewed curve at either end indicating greater or lesser risk reward skewness is a shift of the taller portion of the curve to the right or left if the curve is shifted to the left with a long tail on the right right skew analysts consider it to suggest there is a greater upside reward if it is shifted to the right with a long tail to the left left skew analysts suggest that there is greater downside risk the image below demonstrates normally distributed data with a bell curve the data mean is the line in the middle and the vertical lines are standard deviations or how far data falls from the mean the first two vertical lines on either side of the mean show that 68 5 of the data fall within 1 standard deviation from the mean so if this were a curve of normally distributed stock returns you would see that 68 5 of the time returns fall between the 1 sd and 1 sd lines and that market risk is neutral there is no skew computing the pdf and plotting it graphically can involve complex hazard rate calculations that use differential equations or integral calculus in practice graphing calculators or statistical software packages are required to calculate a probability density function you should note that investment returns are rarely if ever normally distributed so graphs will likely never be a clean normal distribution curve image by julie bang investopedia 2020example of a probability density functionthe probability density function measures continuous variables stock and investment returns are generally not continuous random variables they are discrete however most financial analysts assume that returns and prices are continuous so that they can model performance and analyze risks in the image below the s p 500 index values over three years were sequenced and plotted the result was a bell curve with a right skew indicating the possibility of greater upside reward over the previous three years | |
what does a probability density function pdf tell us | a probability density function pdf describes how likely it is to observe some outcome resulting from a data generating process a pdf can tell us which values are most likely to appear versus the less likely outcomes this will change depending on the shape and characteristics of the pdf | |
what is the central limit theorem clt and how does it relate to pdfs | the central limit theorem clt states that the distribution of a random variable in a sample will begin to approach a normal distribution as the sample size becomes larger regardless of the true shape of the distribution thus we know that flipping a coin is a binary process described by the binomial distribution heads or tails however if we consider several coin tosses the odds of getting any particular combination of heads and tails begin to differ for instance if we were to flip the coin 10 times the odds of getting five of each are most likely but getting 10 heads in a row is extremely rare imagine 1 000 coin flips and the distribution approaches the normal bell curve | |
what is a pdf vs a cdf | a probability density function pdf explains which values are likely to appear in a data generating process at any given time or for any given draw a cumulative distribution function cdf instead depicts how these marginal probabilities add up ultimately reaching 100 or 1 0 of possible outcomes using a cdf we can see how likely it is that a variable s outcome will be less than or equal to some predicted value the bottom lineprobability distribution functions pdfs describe the expected values of random variables drawn from a sample the shape of the pdf explains how likely it is that an observed value might occur stock prices and returns tend to follow a log normal distribution rather than a normal one indicating that downside losses are more frequent than very large gains relative to what the normal distribution would predict | |
what is a probability distribution | a probability distribution is a statistical function that describes all the possible values and likelihoods that a random variable can take within a given range this range will be bounded between the minimum and maximum possible values precisely where the possible value is likely to be plotted on the probability distribution depends on several factors however these factors include the distribution s mean average standard deviation skewness and kurtosis | |
how probability distributions work | perhaps the most common probability distribution is the normal distribution or bell curve although several distributions are commonly used the data generating process of some phenomenon will typically dictate its probability distribution this process is referred to as the probability density function probability distributions can also be used to create cumulative distribution functions cdfs that add up the probability of occurrences cumulatively they ll always start at zero and end at 100 1academics financial analysts and fund managers may determine a particular stock s probability distribution to evaluate the possible expected returns that the stock may yield in the future a stock s history of returns can be measured from any time interval and will likely be composed of only a fraction of the stock s returns this will subject the analysis to sampling error this error can be dramatically reduced by increasing the sample size discrete probability distribution vs continuous probability distributiondiscrete and continuous probability distributions are two fundamental types of probability distributions each describing different kinds of random variables understanding the differences between them is essential for correctly applying statistical methods and interpreting data discrete probability distributions describe scenarios where the set of possible outcomes is countable and finite or countably infinite these distributions are used when the random variable can take on specific distinct values for example the number of heads in ten coin flips or the number of customers arriving at a store in an hour are cases of discrete random variables in these scenarios you can list all possible outcomes such as 0 1 2 and so on it s more likely that discrete probability distributions are more choppy since there are fewer outcomes in contrast continuous probability distributions apply to random variables that can take on any value within a given range these values are not countable because there are infinitely many possibilities within any interval for example the exact height of individuals in a population or the exact time it takes to complete a task are continuous variables it s more likely that continuous probability distributions can have smoother distribution curves since there may be more outcomes types of probability distributionsprobability distributions have many classifications they include the normal distribution chi square distribution binomial distribution and poisson distribution these probability distributions serve different purposes and represent varying data generation processes 12the binomial distribution evaluates the probability of an event occurring several times over a given number of trials given the event s probability in each trial it may be generated by keeping track of how many free throws a basketball player makes in a game where 1 a basket and 0 a miss another example would be to use a coin and figure out the probability of that coin coming up heads in 10 straight flips a binomial distribution is discrete rather than continuous because only one or zero is a valid response 3the most commonly used distribution is the normal distribution this is used frequently in finance investing science and engineering the normal distribution is fully characterized by its mean and standard deviation the distribution isn t skewed and it does exhibit kurtosis this makes the distribution symmetric it s depicted as a bell shaped curve when plotted a normal distribution is defined by a mean average of zero and a standard deviation of 1 0 with a skew of zero and kurtosis 3 approximately 68 of the data collected in a normal distribution will fall within one standard deviation of the mean approximately 95 will fall within two standard deviations and 99 7 will fall within three standard deviations unlike the binomial distribution the normal distribution is continuous all possible values are represented rather than just zero and one with nothing in between 4probability is the mathematical measure of the likelihood that an event will occur it also refers to the branch of mathematics that concerns events and numerical descriptions of how likely they are to occur the poisson distribution is a discrete probability distribution that models the number of events occurring within a fixed interval of time or space these events must happen independently of each other and the average rate mean number of occurrences must be constant the key characteristic of the poisson distribution is that it describes the probability of a given number of events happening within a specified interval when the events are rare and independent the poisson distribution is used in various real world applications where events occur randomly and independently for example it can model the number of customer arrivals at a bank in an hour the number of emails received in a day or the number of phone calls at a call center per minute probability distributions used in investingstock returns are often assumed to be normally distributed but they exhibit kurtosis with large negative and positive returns seeming to occur more than would be predicted by a normal distribution the distribution of stock returns has been described as log normal because stock prices are bounded by zero but offer a potentially unlimited upside this shows up on a plot of stock returns with the tails of the distribution having a greater thickness probability distributions are often used in risk management as well to evaluate the probability and amount of losses that an investment portfolio would incur based on a distribution of historical returns one popular risk management metric used in investing is value at risk var var yields the minimum loss that can occur given the probability and time frame for a portfolio an investor can also get a probability of loss for an amount of loss and time frame using var misuse and overreliance on var have been implicated as one of the major causes of the 2008 financial crisis 5probability distribution and the central limit theoremthe central limit theorem clt is a statistical principle that states that the distribution of the sum of a large number of independent identically distributed random variables approaches a normal distribution this theorem matters because it allows statisticians to make inferences about population parameters even when the population distribution is unknown as long as the sample size is sufficiently large one of the key implications of the clt is that for large sample sizes the sampling distribution of the sample mean will be approximately normally distributed for instance imagine you have a class of students where each student s height varies but on average they tend to be around 5 feet tall with some variability according to the clt the distribution of average height samples will tend to follow a normal bell shaped curve example of a probability distributionlook at the number observed when rolling two standard six sided dice each die has a 1 6 probability of rolling any single number one through six but the sum of two dice will form the probability distribution depicted in this image seven is the most common outcome 1 6 6 1 5 2 2 5 3 4 4 3 two and twelve are far less likely 1 1 and 6 6 | |
what makes a probability distribution valid | two steps determine whether a probability distribution is valid the analysis should determine in step one whether each probability is greater than or equal to zero and less than or equal to one determine in step two whether the sum of all the probabilities is equal to one the probability distribution is valid if both step one and step two are true | |
how are probability distributions used in finance | probability distributions are used in finance in two main ways | |
what are the most commonly used probability distributions | the most commonly used probability distributions are uniform binomial bernoulli normal poisson and exponential 6 | |
what is the difference between probability and odds | probability measures the likelihood of an event occurring expressed as a ratio of the number of favorable outcomes to the total number of possible outcomes odds on the other hand represent the ratio of the probability of an event happening to the probability of it not happening for instance if the probability of winning a game is 0 25 the odds are 1 3 1 win to 3 losses | |
what is the law of large numbers | the law of large numbers states that as the number of trials or experiments increases the average of the results obtained approaches the expected value or true probability this principle assures that the sample mean converges to the population mean as more observations are collected providing stability to statistical inference the bottom lineprobability distributions describe all of the possible values that a random variable can take this is used in investing particularly in determining the possible performance of a stock as well as in the risk management component of investing by helping to determine the maximum loss | |
what is probate | probate is the process completed when a decedent leaves assets to distribute such as bank accounts real estate and financial investments probate is the general administration of a deceased person s will or the estate of a deceased person without a will an executor is commonly named in the will or an administrator if there is no will to complete the probate process this involves collecting the deceased s assets to pay any remaining liabilities on their estate and distributing the assets to beneficiaries | |
how probate works | probate is the analysis and transfer administration of estate assets previously owned by a deceased person when a property owner dies their assets are commonly reviewed by a probate court this court provides the final ruling on the division and distribution of assets to beneficiaries a probate proceeding will typically begin by analyzing whether or not the deceased person has provided a legalized will in many cases the deceased person has established documentation which contains instructions on how their assets should be distributed after death however in some cases the deceased does not leave a will there are special circumstances that occur with both situations that we ve listed below factors for probate lawprobate law is the field of law that determines how an estate must be divided each state has its own laws and statutes requirements to determine if and how an estate must be probated common factors include 1probate with a willa deceased person with a will is known as a testator when a testator dies the executor is responsible for initiating the probate process the executor is typically a family member the will can also provide details on a specified executor the executor is responsible for filing the will with the probate court states can have different rules for the timeframe in which a will must be filed after death filing the will initiates the probate process the probate process is a court supervised proceeding in which the authenticity of the will left behind is proven to be valid and accepted as the true last testament of the deceased the court officially appoints the executor named in the will which gives the executor the legal power to act on behalf of the deceased a will typically designate a legal representative or executor approved by the court this person is responsible for locating and overseeing all the assets of the deceased the executor has to estimate the value of the estate by using either the date of death value or the alternate valuation date as specified by the internal revenue code irc 2most assets that are subject to probate administration come under the supervision of the probate court in the place where the decedent lived at death the exception is real estate probate for real estate may need to be extended to any county in which the real estate is located the executor also has to pay off any taxes and debt owed by the deceased from the estate creditors usually have a limited amount of time approximately one year from the date of death to make any claims against the estate for money owed to them claims that are rejected by the executor can be taken to court where a probate judge will have the final say on whether or not the claim is justified the executor is also responsible for filing the final personal income tax returns on behalf of the deceased any estate taxes that are pending can also come due within one year from the date of death after the inventory of the estate has been taken the value of assets calculated and debts paid off the executor will then seek authorization from the court to distribute whatever is left of the estate to the beneficiaries 3if a deceased person s estate is insolvent which means that their debts outweigh their assets an administrator will likely choose not to initiate probate in general individual states may have their own rulings on a statute of limitations for the processing of a will through probate states can also have thresholds for probate filings trust funds can be orchestrated to pass immediately to designated inheritors upon death probate without a will | |
when a person dies without a will he is said to have died intestate an intestate estate is also one where the will presented to the court has been deemed to be invalid the probate process for an intestate estate includes distributing the decedent s assets according to state laws if a deceased person has no assets probate may not be necessary | in general a probate court proceeding usually begins with the appointment of an administrator to oversee the estate of the deceased the administrator functions as an executor receiving all legal claims against the estate and paying off the outstanding debts the administrator is tasked with locating any legal heirs of the deceased including surviving spouses children and parents the probate court will assess what assets need to be distributed among the legal heirs and how to distribute them the probate laws in most states divide property among the surviving spouse and children of the deceased asset transfer to the government is known as escheatment states do typically have a timeframe for the claiming of any assets by an heir who may step forward community property laws can recognize both spouses as joint property owners in an intestate proceeding in effect the distribution hierarchy typically starts with the surviving spouse if unmarried or widowed at the time of death assets are usually divided among any surviving children after a spouse and children are considered other relatives may also be deemed appropriate for distribution close friends of the deceased will not normally be added to the list of beneficiaries under a state s probate laws for intestate estates however if the deceased had a joint account with right of survivorship or owned property jointly with another the joint asset would automatically be owned by the surviving partner if an individual has no will and no heirs any remaining assets go to the state | |
is a probate always required | it is important to know whether a probate is required following the death of an individual the probate process can take a long time to finalize the more complex or contested the estate is the more time it will take to settle and distribute the assets the longer the duration the higher the cost probating an estate without a will is typically costlier than probating one with a valid will however the time and cost required of each are still high also since the proceedings of a probate court are publicly recorded avoiding probate would ensure that all settlements are done privately different states have different laws concerning probate and whether probate is required after the death of a testator some states have a specified estate value which requires probate for example probate laws in texas hold that if the value of the estate is less than 75 000 then probate may be skipped if an estate is small enough to bypass the probate process then the estate s asset may be claimed using alternative legal actions such as an affidavit typically if a deceased person s debts exceed their assets probate is not necessarily initiated and alternative actions may be taken 4some assets can bypass probate because beneficiaries have been initiated through contractual terms pension plans life insurance proceeds 401k plans medical savings accounts and individual retirement accounts ira that have designated beneficiaries will not need to be probated likewise assets jointly owned with a right of survivorship can bypass the probate process another popular way to bypass probate is through the use of a trust overall minimizing costs associated with the probate process can be prudent accumulated expenses can include court fees professional service hours and administration costs having an easily authenticated will is one of the most common ways to quickly move through a probate process and efficiently distribute assets appropriately | |
how much does probate cost | the cost of the probate process varies depending on your state and your lawyer in some states it is typical for lawyers to process estates for a flat or hourly fee in others they charge a percentage of the estate you will also have to pay for any outstanding debts court and filing fees and the costs of notifying creditors about the probate process in addition you may also have to pay an inheritance tax it is worth researching the probate costs for your state when you begin end of life planning 5 | |
which state has the best probate laws | while probate laws vary from state to state 18 states have adopted the uniform probate code which offers a standardized procedure for dividing a decedent s assets the states that have adopted the upc are idaho alaska 1972 arizona 1973 colorado 1974 minnesota montana nebraska south dakota new mexico utah michigan maine pennsylvania minnesota south carolina hawaii north dakota new jersey and massachusetts 67 | |
how can i avoid probate | each state has its own limit to determine how much an estate must be to go through the probate process smaller estates may be able to go through a simplified probate process or simply have heirs claim assets by affidavit in addition some assets such as living trusts and 401 k plans do not need to go through the probate process since the probate process is expensive it is worth researching your state s probate rules during your end of life planning the bottom lineprobate law deals with the rules that determine how a person s assets are divided after they die each state has its own rules for the probate process depending on the size of the estate the type of assets and the presence of a will since the probate process can be expensive it is worth researching the different ways to structure an estate in order to avoid it | |
what is probate court | probate court is a segment of the judicial system that oversees the execution of wills as well as the handling of estates conservatorships and guardianships probate court also handles the commitment of a person with psychiatric disabilities to institutions designed to help them probate court ensures that a will is executed according to the wishes of the individual who has passed away it makes sure that all debts owed are paid and that assets are distributed properly the court oversees and usually must approve the activities of the executor appointed to handle these matters in addition when a will is contested the probate court is responsible for ruling on the authenticity of the document and the cognitive stability of the person who signed it if no will exists the court also decides who receives the decedent s assets based on the laws of the jurisdiction in place understanding probate courtthe term probate is used to describe the legal process that involves the handling of the estate of a recently deceased person broadly the role of the court is to make sure that their debts are paid and their assets are distributed to the correct beneficiaries according to the decedent s wishes as detailed in a will 12probate is multifaceted in that it refers to the overall legal process of dealing with a deceased person s assets and debt the court that manages the process and the actual distribution of assets individual states have rules concerning probate and probate courts some states do not use the term probate but instead refer to a surrogate s court orphan s court or chancery court it s important to review the laws regarding probate in the state in which a will is to be probated before death if you re creating a will and after death if you are a beneficiary or executor many local courts offer complete instructions concerning probate for example the new york state unified court system allows individuals to search by their county and type of court to begin the probate process 3 | |
what goes through probate | probate is usually necessary for property that is titled only in the name of the person who passes away for example that might include a car or real estate it s also usually necessary for an interest in any property that is owned as tenants in common 42here are some of the assets that don t need to be probated according to legal information expert alllaw the probate court processa formal probate process involves specific usually straightforward steps issues that may arise during the process can lengthen the time it lasts until it is closed by the court an informal probate process also called summary probate that requires less court oversight can be used if the estate is small the will is simple all parties are in agreement with it and no objections are raised the will and death certificate still must be filed in this instance | |
when a person dies with no will the probate court distributes that person s assets to their next of kin according to the relevant state s probate laws this is known as the law of intestate succession it outlines the distribution of assets between surviving spouses children grandchildren siblings parents aunts uncles and other relatives 6 | with or without a will going to probate court is likely required to settle a decedent s affairs however there are ways to simplify the probate process prior to death including creating a living trust naming beneficiaries clearly on all investment bank and retirement accounts and establishing joint ownership for certain assets the costs of probate courta probate lawyer is often hired to help deal with the intricacies of probate other costs of probate can include court filing fees costs for publishing a death notice and an executor s fees if the estate is large and complicated the assistance of an accountant may be needed the deceased s estate lawyer may also need to be involved costs will mount the longer the probate process takes to complete in general the process can take six months to a couple of years | |
how to avoid probate court | understandably people want to avoid or shorten the probate process if possible this can be done by setting up a living trust assigning your assets to it and designating beneficiaries for those assets a living trust is an estate planning tool that can help you avoid the usually lengthy sometimes costly and always public nature of probate you can keep financial assets out of probate court by designating beneficiaries for them in the account paperwork held by for example your life insurance company retirement plan brokerage and bank this way funds will flow directly to the beneficiaries upon your death in addition to avoid probate of money you d like to leave to beneficiaries consider gifts during your lifetime people can give individuals tax free money in the form of gifts as defined by the internal revenue service irs in 2022 the maximum allowable amount is 16 000 17 000 in 2023 per person before a gift tax return must be filed 7frequently asked questions | |
what happens at a probate court hearing | at a probate court hearing the judge will list the responsibilities of the executor of the will including contacting any beneficiaries and creditors appraising the deceased s assets and paying any outstanding creditors and taxes usually at the second court hearing the judge will ensure all these items have been done and close out the estate so that the transfers of money and other assets in the estate may begin | |
do you have to go to probate court when someone dies | each state has specific probate laws to determine what s required unless someone has no assets or descendants when they die probate is usually still required in order to settle the deceased s remaining affairs including debts assets and paying their final bills and taxes | |
how do you avoid probate court | while it can be tricky to avoid probate court completely some ways to avoid probate include creating a living trust naming beneficiaries clearly on all investment bank and retirement accounts and establishing joint ownership for certain assets | |
how long does probate take | the length of time varies depending on the deceased person s assets the complexity of their will and other factors for example the executor may have to liquidate assets to pay creditors selling a home or other property for this purpose can take time generally speaking probate can go from a few weeks to a few years | |
how do you file an objection in probate court | the probate court website usually has forms available to file an objection whether it s an objection to tampering with the will forgery or something else these forms must be submitted at the beginning of the process the bottom lineafter someone passes away the grief over their loss can be all consuming for the remaining family and friends unfortunately the probate process can add an additional burden one that s financial and administrative with or without a will the probate process is essential to understand to ensure that all of one s affairs are in order prior to death | |
what is procurement | procurement is obtaining or purchasing goods or services typically for business purposes procurement is most commonly associated with businesses because companies must solicit services or purchase goods usually on a relatively large scale it can also include the overall procurement process which is critically important for companies leading up to a final purchasing decision companies can be on both sides of the procurement process as buyers or sellers though here we mainly focus on the side of the soliciting company | |
how procurement works | procurement and procurement processes can require a substantial portion of a company s resources to manage procurement budgets typically provide managers with a specific value they can spend to procure the goods or services they need the procurement process is often a vital part of a company s strategy because the ability to purchase specific materials or services can determine if operations will be profitable in many cases procurement processes will be dictated by company standards often centralized by controls from the accounts payable ap division of accounting the procurement process includes the preparation and processing of a demand and the end receipt and approval of payment comprehensively this can involve purchase planning standards specifications determination supplier research selection financing price negotiation and inventory control as such many large companies may require support from a few different areas of a company for successful procurement there are several steps involved in the procurement process procurement can involve support from several areas of a company competitive bidding and procurementcompetitive bidding is a part of most business deals involving multiple bidders the competitive bidding process for goods is usually more simplified than for services procurement is also the term used for purchasing goods and services on behalf of the government which has its own bidding processes and requirements competitive bidding for all types of goods generally involves proposals that detail the per unit price shipping and delivery terms competitive bidding for the procurement of services can be more complex since it may involve individuals technology services operational procedures client servicing training service fees and more in each case the solicitor of bids chooses the supplier they want to work with based on both operational business aspects as well as costs the solicitor is responsible for accounting for expenses depending on the goods or services involved government agencies and large companies may choose to solicit procurement proposals on an annual or scheduled basis to ensure that they maintain the best relationships for their business types of procurementthere are a few different kinds of procurement that businesses can undertake these include procurement vs purchasingprocurement and purchasing are both processes that involve the exchange of goods and services so it isn t uncommon for people to confuse the two but there are certain distinctions between the two for instance procurement is more of a strategic process involving acquiring goods and services it emphasizes the value of products and uses a series of steps as outlined above to complete the acquisition businesses generally take a proactive approach when they submit procurement orders doing so allows them to identify and fill future deficiencies before they are needed purchasing on the other hand is a transactional process as such it involves buying goods and services when an entity purchases goods and services it places greater importance on price rather than value purchasing is usually a reactive process that satisfies a more immediate need the table below highlights the comparison between these two processes accounting for procurementprocurement costs are generally integrated into the financial accounting of a business as procurement involves acquiring goods and or services for the revenue goals of the business as such some companies may hire a chief procurement officer cpo for short to lead these efforts the cpo procurement processing can be divided and analyzed from several angles companies and industries have different ways of managing the procurement of direct and indirect costs goods companies as compared with services companies will also have different ways of managing costs direct spending refers to anything related to the cost of goods sold and production including all items that are part of finished products for manufacturing companies this can range from raw materials to components and parts for merchandising companies this will include the cost of purchasing merchandise from a wholesaler for sales for service based companies direct costs will primarily be the hourly labor costs of employees performing services procurement for items pertaining to the cost of goods sold directly affects a company s gross profit by contrast indirect procurement involves non production related purchases these are purchases a company uses to facilitate its operations indirect procurement can involve a broad range of purchases including office supplies marketing materials advertising campaigns consulting services and more companies will generally have different budgets and processes for managing direct costs compared to indirect costs procurement is part of the expense process for all types of companies but goods and services companies account for revenues and costs differently as such accounting for procured goods will also differ from accounting for procured services companies focused on goods must deal with procuring those goods as inventory these companies place a lot of importance on supply chain management service based companies provide services as their primary revenue generator so they do not necessarily rely as heavily on a supply chain for inventory although they may need to purchase goods for technology based services in general the cost of sales for many service companies is based on the hourly labor cost of employees providing the service so procurement as a direct expense is not a major factor however service based companies will usually have higher relative indirect costs because they typically deal with their own procurement as an indirect expense through marketing | |
what is meant by procurement | procurement is the process involved in obtaining or sourcing something that is needed businesses procure supplies and raw materials while governments may procure contractors or service providers | |
is procurement the same as purchasing | while they are similar procurement typically deals with finding suppliers and sourcing materials whereas purchasing involves the costs and transactions related to buying those goods or materials | |
how is procurement done | procurement can be carried out in several ways organizations may submit an open tender to allow competitive bidding among potential suppliers they may also restrict the number of bidders or establish criteria for who is allowed to bid as an alternative to an auction process an organization may solicit a request for proposals rfp where applicants compete with one another on price and competencies sometimes procurement is done under contract with a single source or small group of exclusive suppliers the bottom lineprocurement is a strategic process that involves the acquisition of goods and services unlike purchasing it consists of a series of steps that are usually taken by businesses to meet certain needs such as production inventory and sales it often involves a series of documents like demands and receipts for payment but don t confuse procurement with purchasing although the two terms are often used interchangeably they are very different unlike procurement purchasing is transactional and normally fulfills more immediate needs | |
what is procyclic | procyclic describes a state where the behavior and actions of a measurable product or service move in tandem with the cyclical condition of the economy understanding procycliceconomic indicators can have one of three different relationships to the economy countercyclic indicator and economy move in opposite directions acyclic indicator has no relevance to the state of the economy or procyclic procyclic refers to a condition of a positive correlation between the value of a good a service or an economic indicator and the overall state of the economy in other words the value of the good service or indicator tends to move in the same direction as the economy growing when the economy grows and declining when the economy declines some examples of procyclic economic indicators are gross domestic product gdp labor and marginal cost most consumer goods are also considered procyclic because consumers tend to buy more discretionary goods when the economy is in good shape policies and fiscal behavior typically fall into procyclic patterns in periods of boom and bust when there is economic prosperity many members of the population will engage in behavior that not only falls in line with that growth but serves to extend the period procyclic examplein the lead up to the housing and financial crisis of the late 2000s there was a collective expectation for ongoing financial gain consumers engaged in more spending borrowers sought mortgages for homes that might have been outside of their means to repay financial institutions encouraged such behavior and government policies did little to deter such trends as long as the market collectively supported the boom nature and fed the economy this continued until the bad debt and other issues became too great to ignore and the markets collapsed the economic climate changed when the bust part of the cycle hit consumer spending dropped banks and loan companies clamped down on their lending practices foreclosures spread across the market on homes with lapsed mortgages and federal legislation was quickly drafted to prevent it all from happening again these were all procyclic responses to the action at hand the further the economy moves away from that crisis period the more spending increases and certain legislation that was deemed onerous by financial institutions might be questioned such behavior is procyclic because unless there is some motivation to act differently there is a desire to remove what would be seen as constraints on choice when the market seems prosperous the trouble with strictly procyclic reactions to the economy is they do not allow for forward thinking behavior that would prepare the market for the declines that will eventually return if preventative legislation is only supported during times of crisis in all likelihood the behavior that contributed to the collapse of the market will be repeated | |
what is the producer price index ppi | the producer price index ppi measures the average change over time in the prices domestic producers receive for their output it is a measure of inflation at the wholesale level that is compiled from thousands of indexes measuring producer prices by industry and product category the index is published monthly by the u s bureau of labor statistics bls the ppi is different from the consumer price index cpi which measures the changes in the price of goods and services paid by consumers understanding the producer price index ppi the ppi measures inflation or much less commonly deflation from the perspective of the product manufacturer or service supplier the price trends for producers and consumers are unlikely to diverge for long since producer prices heavily influence those charged to consumers and vice versa in the short term inflation at the wholesale and retail levels may differ as a result of distribution costs as well as government taxes and subsidies 1the bls releases the ppi along with its constituent industry and product indexes during the second week of the month following the reference date of the survey it is based on approximately 100 000 monthly price quotes reported voluntarily online by more than 25 000 systematically sampled producer establishments 23the ppi reading for the 12 months ending may 2024 on an unadjusted basis the index for final demand decreased by 0 2 in may from april 4the survey covers the entirety of the u s output of goods and about 69 by value of services its component product and services indexes are weighted based on the value of the category s output to calculate the overall change in producer prices 5the ppi is used to forecast inflation and to calculate escalator clauses in private contracts based on the prices of key inputs it is also vital for tracking price changes by industry and comparing wholesale and retail price trends 5producer price index ppi vs consumer price index cpi both ppi and cpi are important economic measures because they point to monthly changes in prices but they reflect prices from different standpoints as noted above the ppi measures prices based on the first commercial transaction for a product or service 5this is in contrast to the consumer price index which measures price changes encountered by the consumer 6the cpi s focus is on the final sale but these two indexes don t just differ based on the type of prices measured there are also important compositional differences between the ppi and the cpi that can be considered these distinctions are based on what s included and left out of each until 1978 the ppi was known as the wholesale price index wpi in 1982 the bls reset all producer price index bases to 100 7for example the ppi does not measure price changes for aggregate housing costs while the cpi s shelter category including the imputed owners equivalent of rents accounts for one third of the overall index meanwhile the ppi incorporates a weighting of nearly 16 6 for healthcare services not far off the sector s weight of nearly 20 in the u s gross domestic product gdp in contrast the cpi s weighting for medical care is 8 that s because it doesn t measure third party healthcare reimbursements 89another key distinction is that the ppi does not include the price of imported goods unlike the cpi conversely the ppi includes export prices while the cpi does not 10 | |
how producer price index ppi numbers are presented | the bls produces more than 10 000 product and industry price indexes each month which it then uses to calculate the ppi they re published with and without seasonal adjustments and are divided into three categories industry level classification commodity classification and first demand intermediate demand 11the ppi includes indexes for producer prices received in each of more than 500 industry categories based on output sold outside the industry the categories are compatible with those used in other releases to report industry level data on production employment earnings and productivity 11commodity classification disregards the producer s industry to group output based on the nature of the product or service the ppi report publishes more than 3 800 commodity price indexes for goods and some 900 for services 11the first demand intermediate demand indexes use the commodity indexes organized by product to measure producer prices based on the economic identity of the buyers and whether the goods sold require further processing the ppi report publishes more than 600 fd id indexes the final demand indexes as distinct from the intermediate demand ones are then used to arrive at the headline ppi number which reflects the ppi for final demand 11 | |
what is in the producer price index | the producer price index measures the average change over time in the selling prices that domestic producers receive for their output the prices included in the ppi are from the first commercial transaction for many products and some services 5 | |
what s the difference between the producer price index and the consumer price index | both the cpi and the ppi measure inflation ppi measures inflation from the viewpoint of the producers the average selling price they receive for their output over time the cpi measures inflation from the viewpoint of the consumer through the value of a basket of goods and services that consumers have bought over a certain period 10 | |
what does the producer price index predict | the producer price index looks at inflation from the viewpoint of industry and business this method measures price changes before consumers purchase final goods and services as a result many analysts consider it to predict inflation before the cpi the bottom linethe producer price index is a measure of the change in prices that domestic producers receive for their goods and services the index is a measure of wholesale inflation and an indicator of the health of the economy | |
what is a producer surplus | producer surplus is the difference between how much a person would be willing to accept for a given quantity of a good versus how much they can receive by selling the good at the market price the difference or surplus amount is the benefit the producer receives for selling the good in the market a producer surplus is generated by market prices in excess of the lowest price producers would otherwise be willing to accept for their goods this may relate to walras law investopedia jiaqi zhouunderstanding producer surplusa producer surplus is shown graphically below as the area above the producer s supply curve that it receives at the price point p i forming a triangular area on the graph the producer s sales revenue from selling q i units of the good is represented as the area of the rectangle formed by the axes and the red lines and is equal to the product of q i times the price of each unit p i because the supply curve represents the marginal cost of producing each unit of the good the producer s total cost of producing q i units of the good is the sum of the marginal cost of each unit from 0 to q i and is represented by the area of the triangle under the supply curve from 0 to q i subtracting the producer s total cost the triangle under the supply curve from his total revenue the rectangle shows the producer s total benefit or producer surplus as the area of the triangle between p i and the supply curve the size of the producer surplus and its triangular depiction on the graph increases as the market price for the good increases and decreases as the market price for the good decreases special considerationsproducers would not sell products if they could not get at least the marginal cost to produce those products the supply curve as depicted in the graph above represents the marginal cost curve for the producer from an economics standpoint marginal cost includes opportunity cost in essence an opportunity cost is a cost of not doing something different such as producing a separate item the producer surplus is the difference between the price received for a product and the marginal cost to produce it because marginal cost is low for the first units of the good produced the producer gains the most from producing these units to sell at the market price each additional unit costs more to produce because more and more resources must be withdrawn from alternative uses so the marginal cost increases and the net producer surplus for each additional unit is lower and lower profit is a closely related concept to producer surplus however they differ slightly economic profit takes revenues and subtracts both fixed and variable costs producer surplus on the other hand only takes off variable marginal costs consumer surplus and producer surplusa producer surplus combined with a consumer surplus equals overall economic surplus or the benefit provided by producers and consumers interacting in a free market as opposed to one with price controls or quotas if a producer could price discriminate correctly or charge every consumer the maximum price the consumer is willing to pay then the producer could capture the entire economic surplus in other words producer surplus would equal overall economic surplus however the existence of producer surplus does not mean there is an absence of a consumer surplus the idea behind a free market that sets a price for a good is that both consumers and producers can benefit with consumer surplus and producer surplus generating greater overall economic welfare market prices can change materially due to consumers producers a combination of the two or other outside forces as a result profits and producer surplus may change materially due to market prices producer surplus examplesay that there are 20 companies that make widgets each producing them at slightly different costs ranging from 2 50 to 3 50 per widget in the market there is an equilibrium point where the amount of widgets supplied meets demand at 3 00 the producer surplus would define those producers who can make widgets for less than 3 00 down to 2 50 while those whose costs are up to 3 50 will experience a loss instead for the lowest cost producer they would enjoy a surplus of 0 50 per widget | |
how do you measure producer surplus | with supply and demand graphs used by economists the producer surplus would be equal to the triangular area formed above the supply line over to the market price it can be calculated as the total revenue less the marginal cost of production | |
what is producer surplus simply put | put simply the producer surplus is the difference between the price that companies are willing to sell products for and the prices that they actually get for them | |
what is total surplus | total economic surplus is equal to the producer surplus plus the consumer surplus | |
what is product differentiation | product differentiation distinguishes one company s products or services from its competition successful product differentiation leads to brand loyalty and sales a product differentiation strategy identifies and communicates the unique qualities of a product or company while highlighting the differences between that product or company and its competitors product differentiation can create a competitive advantage for the product s seller and build brand awareness investopedia sydney burnsmarketing strategyproduct differentiation is a marketing strategy to encourage consumers to choose one brand or product over another it identifies the qualities that set one product apart from similar products and uses those differences to drive consumer choice differentiation marketing may also focus on a niche market differentiating qualities may be reflected in a product s packaging marketing promotion or brand name a strategy may require adding new functional features or might be as simple as redesigning packaging sometimes differentiation marketing does not require any changes to the product but a new advertising campaign or other promotions the differences between products can be physical or measurable such as the lowest price gym in a region however the differences between the products could be more abstract such as a car company claiming their cars are the most luxurious product differentiation aims to alter a consumer s interpretation of the benefits of one item compared to another the actual difference in the product compared with competing products might be small or nonexistent companies that achieve high market research metrics for brand loyalty and customer loyalty grow revenues 2 5 times faster than industry peers and deliver two to five times the returns to shareholders over 10 year time frames according to a study by the harvard business review 1 | |
what is the product life cycle | the term product life cycle refers to the length of time from when a product is introduced to consumers into the market until it s removed from the shelves this concept is used by management and by marketing professionals as a factor in deciding when it is appropriate to increase advertising reduce prices expand to new markets or redesign packaging the process of strategizing ways to continuously support and maintain a product is called product life cycle management investopedia xiaojie liu | |
how the product life cycle works | products like people have life cycles the life cycle of a product is broken into four stages introduction growth maturity and decline a product begins with an idea and within the confines of modern business it isn t likely to go further until it undergoes research and development r d and is found to be feasible and potentially profitable at that point the product is produced marketed and rolled out some product life cycle models include product development as a stage though at this point the product has not yet been brought to customers as mentioned above there are four generally accepted stages in the life cycle of a product here are details about each one the introduction phase is the first time customers are introduced to the new product a company must generally includes a substantial investment in advertising and a marketing campaign focused on making consumers aware of the product and its benefits especially if it is broadly unknown what the item will do during the introduction stage there is often little to no competition for a product as competitors may just be getting a first look at the new offering however companies still often experience negative financial results at this stage as sales tend to be lower promotional pricing may be low to drive customer engagement and the sales strategy is still being evaluated if the product is successful it then moves to the growth stage this is characterized by growing demand an increase in production and expansion in its availability the amount of time spent in the introduction phase before a company s product experiences strong growth will vary from between industries and products during the growth phase the product becomes more popular and recognizable a company may still choose to invest heavily in advertising if the product faces heavy competition however marketing campaigns will likely be geared towards differentiating its product from others as opposed to introducing the goods to the market a company may also refine its product by improving functionality based on customer feedback financially the growth period of the product life cycle results in increased sales and higher revenue as competition begins to offer rival products competition increases potentially forcing the company to decrease prices and experience lower margins the maturity stage of the product life cycle is the most profitable stage the time when the costs of producing and marketing decline with the market saturated with the product competition now higher than at other stages and profit margins starting to shrink some analysts refer to the maturity stage as when sales volume is maxed out depending on the good a company may begin deciding how to innovate its product or introduce new ways to capture a larger market presence this includes getting more feedback from customers and researching their demographics and their needs during the maturity stage competition is at the highest level rival companies have had enough time to introduce competing and improved products and competition for customers is usually highest sales levels stabilize and a company strives to have its product exist in this maturity stage for as long as possible a new product needs to be explained while a mature product needs to be differentiated as the product takes on increased competition as other companies emulate its success the product may lose market share and begin its decline product sales begin to drop due to market saturation and alternative products and the company may choose to not pursue additional marketing efforts as customers may already have determined whether they are loyal to the company s products or not | |
should a product be entirely retired the company will stop generating support for it and will entirely phase out marketing endeavors alternatively the company may decide to revamp the product or introduce a next generation completely overhauled model if the upgrade is substantial enough the company may choose to re enter the product life cycle by introducing the new version to the market | the stage of a product s life cycle impacts the way in which it is marketed to consumers a new product needs to be explained while a mature product needs to be differentiated from its competitors advantages of using the product life cyclethe product life cycle better allows marketers and business developers to better understand how each product or brand sits with a company s portfolio this enables the company to internally shift resources to specific products based on those products positioning within the product life cycle for example a company may decide to reallocate market staff time to products entering the introduction or growth stages alternatively it may need to invest more cost of labor in engineers or customer service technicians as the product matures the product life cycle naturally tends to have a positive impact on economic growth as it promotes innovation and discourages supporting outdated products as products move through the life cycle stages companies that use the product life cycle can realize the need to make their products more effective safer efficient faster cheaper or better suited to client needs limitations of using the product life cycledespite its utility for planning and analysis the product life cycle doesn t pertain to every industry and doesn t work consistently across all products consider popular beverage lines whose primary products have been in the maturity stage for decades while spin offs or variations of these drinks from the same company have failed the product life cycle also may be artificial in industries with legal or trademark restrictions consider the new patent term of 20 years from which the application for the patent was filed in the united states 1 though a drug may be just entering their growth stage it may be adversely impacted by competition when its patent ends regardless of which stage it is in another unfortunate side effect of the product life cycle is prospective planned obsolescence when a product enters the maturity stage a company may be tempted to begin planning its replacement this may be the case even if the existing product still holds many benefits for customers and still has a long shelf life for producers who tend to introduce new products every few years this may lead to product waste and inefficient use of product development resources notification messages such as microsoft s alert that windows 8 1 will sunset on january 2023 is an example of decline 2 due to obsolescence of the operating system microsoft is choosing to no longer support the product and instead focus resources on newer technologies product life cycle vs bcg matrixa similar analytical tool to determine the market positioning of a product is the boston consulting group bcg matrix this four square table defines products based on their market growth and market share although there is no direct relationship between the matrix and the product life cycle concept both analyze a product s market growth and saturation however the bcg matrix does not traditionally communicate the direction in which a product will move for example a product that has entered the maturity stage of the product life cycle will likely experience decline next the bcg matrix does not communicate this product flow in its visual depiction introduction and maturity special considerationscompanies that have a good handle on all four stages can increase profitability and maximize their returns those that aren t able to may experience an increase in their marketing and production costs ultimately leading to the limited shelf life for their product s back in 1965 theodore levitt a marketing professor wrote in the harvard business review that the innovator is the one with the most to lose because so many truly new products fail at the first phase of their life cycle the introductory stage the failure comes only after the investment of substantial money and time into research development and production this fact prevents many companies from even trying anything really new instead he said they wait for someone else to succeed and then clone the success 3to cite an established and still thriving industry television program distribution has related products in all stages of the product life cycle oled tvs are in the mature phase programming on demand is in the growth stage dvds are in decline and the videocassette is extinct many of the most successful products on earth are suspended in the mature stage for as long as possible undergoing minor updates and redesigns to keep them differentiated examples include apple computers and iphones ford s best selling trucks and starbucks coffee all of which undergo minor changes accompanied by marketing efforts are designed to keep them feeling unique and special in the eyes of consumers examples of product life cyclesmany brands that were american icons have dwindled and died better management of product life cycles might have saved some of them or perhaps their time had just come oldsmobile began producing cars in 1897 after merging with general motors in 1908 the company used the first v 8 engine in 1916 by 1935 the one millionth oldsmobile had been built in 1984 oldsmobile sales peaked selling more cars in that year than any other year by 2000 general motors announced it would phase out the automobile and on april 29th 2004 the last oldsmobile was built 4in 1905 frank winfield woolworth incorporated f w woolworth co a general merchandise retail store by 1929 woolworth had about 2 250 outlet stores across the united states and britain decades later due to increased competition from other discount retailors woolworth closed the last of its variety stores in the united states in 1997 to increasingly focus on sporting goods 5on april 23 1985 coca cola announced a new formula for its popular beverage referred to as new coke coca cola s market share lead had been decreasing over the past 15 years and the company decided to launch a new recipe in hopes of reinvigorating product interest after its launch coca cola s phone line began receiving 1 500 calls per day many of which were to complain about the change protest groups recruited 100 000 individuals to support their cause of bringing old coke back 6a stunning 79 days after its launch new coke s full product life cycle was complete though the product didn t experience much growth or maturity its introduction to the market was met with heavy protest less than three months after it announced its new recipe coca cola announced it would revert its product back to the original recipe | |
what are the stages of the product life cycle | the product life cycle is defined as four distinct stages product introduction growth maturity and decline the amount of time spent in each stage will vary from product to product and different companies have different strategic approaches to transitioning from one phase to the next | |
what are product life cycle strategies | depending on the stage a product is in a company may adopt different strategies along the product life cycle for example a company is more likely to incur heavy marketing and r d costs in the introduction stage as the product becomes more mature companies may then turn to improving product quality entering new segments or increasing distribution channels companies also strategically approach divesting from product lines including the sale of divisions or discontinuation of goods | |
what is product life cycle management | product life cycle management is the act of overseeing a product s performance over the course of its life throughout the different stages of product life cycle a company enacts strategies and changes based on how the market is receiving a good | |
why is product life cycle important | product life cycle is important because it informs management of how its product is performing and what strategic approaches it may take by being informed of which stage its product s are in a company can change how it spends resources which products to push how to allocate staff time and what innovations they want to research next | |
which factors impact a product s life cycle | countless factors can affect how a product performs and where it lies within the product life cycle in general the product life cycle is heavily impacted by market adoption ease of competitive entry rate of industry innovation and changes to consumer preferences if it is easier for competitors to enter markets consumers change their mind frequently about the goods they consume or the market becomes quickly saturated then products are more likely to have shorter lives throughout a product life cycle the bottom linebroadly speaking almost every product sold undergoes the product life cycle this cycle of market introduction growth maturity and decline may vary from product to product or industry to industry however this cycle informs a company of how to best utilize its resources what the future outlook of their product is and how to strategically plan for bringing new products to market | |
what is a product line | a product line is a group of related products all marketed under a single brand name that is sold by the same company companies sell multiple product lines under their various brand names seeking to distinguish them from each other for better usability for consumers companies often expand their offerings by adding to existing product lines because consumers are more likely to purchase products from brands with which they are already familiar a company s blend of product lines is known as its product mix or product portfolio investopedia mira norian | |
how product lines work | product lines are created by companies as a marketing strategy to capture the sales of consumers who are already buying the brand the operating principle is that consumers are more likely to respond positively to brands they know and love and will be willing to buy the new products based on their positive experiences with the brand in the past for example a cosmetic company that s already selling a high priced product line of makeup that might include foundation eyeliner mascara and lipstick under one of its well known brands might launch a product line under the same brand name but at a lower price point product lines can vary in quality price and target market companies use product lines to gauge trends which helps them to determine which markets to target the evolution of product linescompanies add new items to their product lines sometimes referred to as a product line extension to introduce brands to new customers consumers who have no interest in a company s sporting goods for example might be more interested in buying its product line of energy bars or sports beverages extending product lines allows companies to maximize their reach the way that companies use product lines is evident in the auto industry auto manufacturers famously produce various product lines of vehicles to reach the widest possible range of consumers for this reason they produce lines of economy vehicles environmentally friendly vehicles and luxury vehicles all under their leading brands some are marketed to families some to individuals and others to the young expanding product lines enables a company to target consumers who are either already buying the brand or are likely to buy the brand product line vs product mixa product line refers to a particular good or service that a company makes and markets to customers a food company may extend a product line by adding various similar or related products e g adding mesquite bbq flavor to its existing potato chips line and create a more diversified product family the product family supplies various products under the same brand name that are similar but meet slightly different needs or tastes potentially attracting more and different customers if the company branches out and starts producing pretzels this would be a different product line altogether involving different ingredients processes and knowledge to make it would also attract many of the same but also different customers as its potato chips line pretzels however would not be in the same product line or family thus adding pretzels expands the firm s product portfolio also known as its product mix the product mix is important to analyze since it can identify which market segments are experiencing what trends companies may thus re brand or restructure underperforming and unprofitable products while profitable lines may be tagged to include innovative or riskier new additions to that product family mature companies often have diversified product mixes internal product development and acquisitions contribute to its product portfolio size over time and larger enterprises have the infrastructure to support the marketing of a broader offering geographic expansion can also augment a product portfolio with products varying in popularity among cities or countries apple inc for example now has a product mix that includes its wildly popular iphone devices within which are various generations versions sizes all at different price points the ios app store its line of laptop desktop computers software development music streaming service apple tv and so on special considerationsproduct lines allow companies to reach regions and socioeconomic groups sometimes even worldwide in some cases such as the cosmetic industry companies also launch product lines under their best selling brands to capture sales from consumers of various ethnic or age groups multinational corporations such as restaurants often launch product lines specifically for the countries in which they operate as is the case with fast food restaurants operating in asia unprofitable product lines may still be useful for a company a loss leader strategy for example introduces new customers to a service or product in the hopes of building a customer base and securing future recurring revenue the product loses money but is sold to attract new customers or sell additional products and services to those customers that are profitable in the future examples of product linesnote that some companies never diversify beyond a single product line instead they focus their efforts on becoming a market leader in just one thing michelin for instance only produces tires crocs only makes rubber based footwear gorilla glue only makes adhesives frequently asked questionswhile a company s product lines will depend on the particular business segment or industry that it operates in marketing and organizational scholars have identified four different classifications of product line based on what is needed to bring that line to market these include filling refers to adding more items to a product line family in order to address any perceived gaps in the potential customer base for instance adding larger sizes to a clothing line can accommodate people with bigger bodies having sizes that fit the vast majority of individuals would fill that product line along that dimension offering different versions of an otherwise same product or service at different price points can help fill a product line based on consumer spending preferences and affluence car manufacturers typically offer the same base model for a given year in different trim ranging from a no frills economy version to a decked out luxury version with all the expensive add ons these price points will attract different consumers with different budgets a company will develop a product line based on the type of business it is its particular expertise and its marketing strategy market testing r d and advertising campaigns are all important to bring a product line to market unsuccessful product lines that are unprofitable should be abandoned in favor of viable ones | |
what is a product portfolio | a product portfolio is the collection of all the products or services offered by a company each with a different growth rate and market share 1 product portfolio analysis can provide nuanced views on a stock type company growth prospects profit margin drivers income contributions market leadership and operational risk this is essential for investors conducting equity research or analysts supporting internal corporate financial planning understanding product portfoliosproduct portfolios are an important element of financial analysis because they provide context and granularity to a firm and its primary operations investors can distinguish between long term value stocks and short term asset growth opportunities portfolio analysis of a firm s product offerings also allows investors to nail down specific drivers of financial performance which is necessary for effective modeling the various components of a portfolio also face different market dynamics and can contribute inconsistently to the bottom line a firm s market share can vary among the parts of its offering with more dominant products generally requiring different strategies from high growth portions of the portfolio a shifting sales mix can have significant consequences for the bottom line when margins vary across the portfolio companies often rebrand or restructure underperforming and unprofitable products a strategy that requires portfolio analysis products that contribute the most income are generally the most important for short term financial analysis and alterations to these flagship elements of the portfolio impact performance more substantially apple inc is known for offering a variety of electronic devices but the iphone is the most important driver of top line and bottom line results this smartphone contributed nearly 48 of total company sales as of the fourth quarter of 2022 meaning its performance is more meaningful than that of apple s laptops ipad or app store 2product portfolios and mature companiesmature companies often have diversified product portfolios because internal product development and acquisitions contribute to portfolio size over time and larger enterprises have the infrastructure to support the marketing of a broader offering geographic expansion can also augment a product portfolio with products varying in popularity among cities or countries diversification tends to limit growth potential while reducing downside risk so mature firms tend to exhibit less operational volatility this reduces the amount of speculation in equity valuation the procter gamble co is an example of such a company with 65 different well known personal and household goods brands including bounty charmin crest gillette and tide 3product portfolios and growth companiesyounger firms with small portfolios are more exposed to the performance of their main products which can lead to greater operational volatility more risk and higher growth potential lead to more speculative equity valuation the various components in a product portfolio often have disparate margins because they have different price dynamics production costs or marketing demands | |
what is a product portfolio | a product portfolio contains every product or service that a company provides each of which will differ with regard to growth rate and market share products with high profit margins will often subsidize those with low ones | |
what is product portfolio analysis | analyzing a profit portfolio is de rigueur for the successful operation of a company knowing which products are making the most money which have low profits but growth potential and which are underperforming is crucial to economic success | |
how do product portfolios differ among companies | each product portfolio will of course be specific to the company in question meaning no two portfolios are exactly alike though they may be similar older companies generally have portfolios that are more greatly diversified than younger companies having been in business longer with more opportunity to expand as a result they have less operational volatility than younger companies which may rely upon the performance of fewer products opening them up to greater risk the bottom lineall the products and services offered by a company constitute its product portfolio analyzing a company s product portfolio allows investors and internal analysts to assess its strengths and growth potential as well as the risks that investing in it could entail there are significant differences between the portfolios of mature companies and younger firms | |
what are production costs | production costs refer to all of the direct and indirect costs businesses face from manufacturing a product or providing a service production costs can include a variety of expenses such as labor raw materials consumable manufacturing supplies and general overhead investopedia crea taylorunderstanding production costsproduction costs which are also known as product costs are incurred by a business when it manufactures a product or provides a service these costs include a variety of expenses for example manufacturers have production costs related to the raw materials and labor needed to create the product service industries incur production costs related to the labor required to implement the service and any costs of materials involved in delivering the service 1taxes levied by the government or royalties owed by natural resource extraction companies are also treated as production costs 1 once a product is finished the company records the product s value as an asset in its financial statements until the product is sold recording a finished product as an asset serves to fulfill the company s reporting requirements and inform shareholders to qualify as a production cost an expense must be directly connected to generating revenue for the company total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs 1 data like the cost of production per unit or the cost to produce one batch of product can help a business set an appropriate sales price for the finished item to arrive at the cost of production per unit production costs are divided by the number of units manufactured in the period covered by those costs to break even the sales price must cover the cost per unit prices that are greater than the cost per unit result in profits whereas prices that are less than the cost per unit result in losses 1types of production costsproduction incurs both fixed costs and variable costs for example fixed costs for manufacturing an automobile would include equipment as well as workers salaries as the rate of production increases fixed costs remain steady 1variable costs increase or decrease as production volume changes utility expenses are a prime example of a variable cost as more energy is generally needed as production scales up 1the marginal cost of production refers to the total cost to produce one additional unit in economic theory a firm will continue to expand the production of a good until its marginal cost of production is equal to its marginal product marginal revenue this in turn will tend to equal its selling price special considerationsthere may be options available to producers if the cost of production exceeds a product s sale price the first thing they may consider doing is lowering their production costs if this isn t feasible they may need to reconsider their pricing structure and marketing strategy to determine if they can justify a price increase or if they can market the product to a new demographic if neither of these options works producers may have to suspend their operations or shut down permanently 1here s a hypothetical example to show how this works using the price of oil let s say oil prices dropped to 45 a barrel if production costs varied between 20 and 50 per barrel then a cash negative situation would occur for producers with steep production costs these companies could choose to stop production until sale prices returned to profitable levels | |
how are production costs determined | for an expense to qualify as a production cost it must be directly connected to generating revenue for the company manufacturers carry production costs related to the raw materials and labor needed to create their products service industries carry production costs related to the labor required to implement and deliver their service royalties owed by natural resource extraction companies also are treated as production costs as are taxes levied by the government | |
how are production costs calculated | production incurs both direct costs and indirect costs direct costs for manufacturing an automobile for example would be materials like plastic and metal as well as workers salaries indirect costs would include overhead such as rent and utility expenses total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs to determine the product cost per unit of product divide this sum by the number of units manufactured in the period covered by those costs 1 | |
how does production costs differ from manufacturing costs | production cost refers to all of the expenses associated with a company conducting its business while manufacturing cost represents only the expenses necessary to make the product whereas production costs include both direct and indirect costs of operating a business manufacturing costs reflect only direct costs | |
what is production efficiency | production efficiency is an economic term describing a level at which an economy or entity can no longer produce additional amounts of a good without lowering the production level of another product this happens when production is reportedly occurring along a production possibility frontier ppf understanding production efficiencyin economics the concept of production efficiency centers around the charting of a production possibility frontier economists and operational analysts will typically also consider some other financial factors such as capacity utilization and cost return efficiency when studying economic operational efficiency in general economic production efficiency refers to a level of maximum capacity in which all resources are being fully utilized to generate the most cost efficient product possible at maximum production efficiency an entity cannot produce any additional units without drastically altering its production process the company will seek to gain added capacity capabilities by lowering the production of another product the federal reserve provides a monthly report on industrial production and capacity utilization which can help understand production efficiency for the manufacturing mining electric and gas utilities sectors 1 analysis of production efficiency also involves a close look at costs generally economic production efficiency simultaneously suggests that products within scope are being created at their lowest average total cost from this perspective economies of scale and cost return efficiency measures are also analyzed overall maximum production efficiency can be difficult to attain as such economies and many individual entities aim to find a good balance between the use of resources the rate of production and the quality of the goods being produced without necessarily maxing out production at full capacity operational managers must keep in mind that when maximum production efficiency has been reached it is not possible to produce more goods without drastically altering portfolio production production possibility frontierthe production possibility frontier is central to the economic concept of production efficiency theoretically variables are charted along the x and y axis showing maximum production levels that can be achieved through simultaneous production maximum economic production efficiency therefore includes all of the points along the production possibility frontier curve excel and other similar software make charting the curve easier the ppf curve shows the maximum production level for each good if an economy or entity cannot make more of a good without lowering the production of another good then a maximum level of production has been reached pff curves aren t always two dimensional as we ll discuss in the next section consider how companies can have dozens if not hundreds of products to manufacture example of pff curveimagine a company faced with the decision to produce either guns or butter the ppf represents the maximum output combinations of two goods that can be produced given fixed resources and technology in this scenario the company can produce 100 guns 100 units of butter or any combination along the ppf where resources are allocated efficiently see the graph below for the graphical example initially if the company produces 100 guns it utilizes all available resources for gun production maximizing output in this sector conversely if it produces 100 units of butter resources are allocated solely to butter production these points on the ppf illustrate the efficient use of resources dedicated entirely to either guns or butter however the company can also produce points such as 80 guns and 60 units of butter this allocation shows a trade off between guns and butter production to achieve this combination resources are shifted from gun production to butter production demonstrating the opportunity cost of producing fewer guns to produce more butter as long a the company manufactures along the pff line any combination of goods is considered efficient this fictitious and somewhat silly example is helpful to understand how more complex intricate companies must decide between trade offs consider international firms like apple which must allocate resources between iphones macbooks software development virtual reality or accessories like airpods measuring efficiencyin addition to operating based on a ppf analysis of production efficiency can also take other forms analysts can measure efficiency by dividing output over a standard output rate and multiplying by 100 to get a percentage this calculation can be used to analyze the efficiency of a single employee groups of employees or sections of an economy at large the formula looks like this efficiency output rate standard output rate 1 0 0 text efficiency text output rate div text standard output rate times100 efficiency output rate standard output rate 100 the standard output rate is a rate of maximum performance or the maximum volume of work produced per unit of time using a standard method when maximum production efficiency is achieved for any sample under analysis then production efficiency will be at 100 if an economy is producing efficiently then it will have a production efficiency of 100 productivity vs efficiencyproductivity is a measure of output relative to input it s typically expressed as a ratio of what is produced goods or services to the resources used in production labor hours materials or capital for example if a factory produces 100 units per hour of labor its productivity would be 100 units hour efficiency on the other hand is about how well resources are used in the production process it s concerned with minimizing waste and maximizing the output for a given set of inputs efficiency takes into account not just the quantity of output but also the quality and the optimal use of resources for example if a factory can utilize the same resources as above but produce 110 units per hour it is capitalizing on efficiency a process can be productive without being efficient the most successful operations strive to be both productive and efficient especially as a company scales for instance when a start up comes to market its proof of concept is based entirely on its ability to produce its goods as the company grows or encounters capital constraints this is when the company s efficiency comes into play production efficiency and economies of scaleeconomies of scale refer to the cost advantages that businesses obtain due to their scale of operation with cost per unit of output generally decreasing as the scale increases this concept is closely tied to production efficiency as it directly impacts how effectively a company can produce goods or services as a firm grows and production increases it can benefit from economies of scale it can try bulk purchasing raw materials at discounted rates spreading fixed costs over a larger number of units produced and the ability to use more specialized and efficient machinery larger operations can also benefit from learning effects where workers become more skilled and efficient over time the relationship between economies of scale and production efficiency is not always linear though while increasing scale often leads to greater efficiency up to a certain point there may come a time when diseconomies of scale set in this means when the operation becomes so large that coordination problems bureaucratic inefficiencies or other factors begin to increase costs per unit production efficiency and market competitionmarket competition is a powerful driver of production efficiency competition creates constant pressure on firms to outperform their rivals in a competitive market companies that fail to maintain or improve their efficiency risk losing market share to more efficient competitors or in extreme cases being forced out of the market entirely as goods become too expensive or unprofitable to manufacture one of the primary ways competition drives efficiency improvements is through innovation companies in competitive markets are motivated to invest in research and development seeking new technologies processes or organizational structures that can give them a competitive edge consider how tesla re designed its assembly line and according to assembly magazine was able to reduce ev production costs by 50 2competition also encourages companies to optimize their resource allocation firms are compelled to critically examine their production processes identifying and eliminating wasteful practices reducing unnecessary costs and maximizing the utilization of their assets for instance think about starbucks and its drive for waste reduction by moving towards reusable personal cups starbucks is able to reduce its cost per drink as no disposable cup lid or straw would be needed 3 | |
why is production efficiency important | by maximizing output while minimizing costs companies can enhance their profitability margins efficient production also contributes to meeting customer demand faster maintaining quality standards and reducing environmental impact | |
how is production efficiency measured | production efficiency is typically measured using various key performance indicators kpis such as overall equipment effectiveness oee labor productivity cycle time defect rates and capacity utilization it can also be visualized by pff graphs | |
how does lean manufacturing contribute to production efficiency | lean manufacturing principles focus on eliminating waste and optimizing processes to improve efficiency techniques such as just in time jit production continuous improvement kaizen and value stream mapping help identify and eliminate non value added activities reduce lead times and improve overall productivity | |
how can supply chain management affect production efficiency | effective supply chain management plays a role in production efficiency by ensuring the timely availability of raw materials and components reducing lead times and optimizing inventory levels companies can be more efficient when they have what they need on hand supply chain management makes sure they have what they need when they need it the bottom lineproduction efficiency refers to maximizing output while minimizing input resources such as labor materials and time it involves optimizing processes reducing waste and improving productivity to achieve higher profitability and competitiveness in the market | |
what is the production possibility frontier ppf | the production possibility frontier ppf is a curve on a graph that illustrates the possible quantities that can be produced of two products if both depend upon the same finite resource for their manufacture the ppf is also referred to as the production possibility curve ppf also plays a crucial role in economics for example it can demonstrate that a nation s economy has reached the highest level of efficiency possible joules garcia investopediaunderstanding the production possibility frontier ppf the ppf is the area on a graph representing production levels that cannot be obtained given the available resources the curve represents optimal levels here are the assumptions involved if a company is deciding how much of each product to produce it can plot points on a graph representing the number of products made using variables based on amounts of available resources considering that resources are limited if the desire is to produce more of one product resources must be taken away from the other as resources are taken from one product and allocated to the other another point can be plotted on the curve when you plot the points where more of x will be produced by taking resources from y or vice versa a curve is generated representing the maximum amount of each product that can be produced as resources are reallocated for example if a nonprofit agency provides a mix of textbooks and computers the curve may show that it can provide either 48 textbooks and six computers or 72 textbooks and two computers this results in a ratio of about six textbooks to one computer the agency s leadership must determine which item is more urgently needed in this example the opportunity cost of providing an additional 30 textbooks equals five more computers so it would only be able to give out one computer with 78 textbooks if it wanted more computers it would need to reduce the number of textbooks by six for every computer | |
when this is plotted the area below the curve represents computers and textbooks that are not being used and the area above the curve represents donations that cannot happen with the available resources the area above the curve is called the production possibility frontier and the curve the line itself is sometimes called the opportunity cost curve the entire graph is sometimes referred to as the production possibility curve | the nonprofit could provide 10 textbooks and 10 computers but this is not using all of its resources this would be represented by a plot beneath the curve a plot would be placed above the curve in the frontier area if the company wanted to give more than its resources provided such as 85 textbooks and no computers or 42 textbooks and 10 computers it simply can t do so based on available resources this technique can be used by economists to determine the set of points at which a country s economy is most efficiently allocating its resources to produce as many goods as possible if the production level is on the curve the country can only produce more of one good if it produces less of some other good if the economy is producing less than the quantities indicated by the curve this signifies that resources are not being used to their full potential in this case it is possible to increase the production of some goods without cutting production in other areas the production possibility frontier demonstrates that there are limits on production given that the assumptions hold therefore each economy must decide what combination of goods and services should be produced to attain maximum resource efficiency production possibility frontier ppf on a national scaleimagine a national economy that can produce only two things wine and cotton if points a b and c are plotted on a curve it represents the economy s most efficient use of resources for instance producing five units of wine and five units of cotton point b is just as attainable as producing three units of wine and seven units of cotton point x represents an inefficient use of resources while point y represents a goal that the economy simply cannot attain with its present levels of resources as we can see for this economy to produce more wine it must give up some of the resources it is currently using to produce cotton point a if the economy starts producing more cotton represented by points b and c it would need to divert resources from making wine and consequently will produce less wine than it is producing at point a moreover by moving production from point a to b the economy must decrease wine production by a small amount compared to the increase in cotton output but if the economy moves from point b to c wine output will be reduced by about 50 while the cotton output only increases by about 75 keep in mind that a b and c all represent the most efficient allocation of resources for the economy the nation must decide how to achieve the ppf and which combination to use for example if more wine is in demand the cost of increasing its output is proportional to the cost of decreasing cotton production markets play an important role in telling the economy what the ppf should look like consider point x in the figure above if a country is producing at point x that means its resources are not being used efficiently in other words the country is not producing enough cotton or wine given the potential of its resources on the other hand point y as we mentioned above represents an unattainable output level an economy can only be produced on the ppf curve in theory economies constantly struggle to reach an optimal production capacity scarcity always forces an economy to forgo some choice in favor of another the only way for the curve to move outward to point y is if there were an improvement in cotton and grape harvesting technology because the available resources land labor and capital generally remain constant as output increased the ppf curve would be pushed outward a new curve represented in the figure on which y would fall would show the new optimal allocation of resources | |
when the ppf shifts outward it implies growth in an economy when it shifts inward the economy is shrinking due to a failure to allocate resources and optimal production capability a shrinking economy could result from a decrease in supplies or a deficiency in technology | production possibility frontier ppf and the pareto efficiencythe pareto efficiency a concept named after italian economist vilfredo pareto measures the efficiency of the commodity allocation on the ppf the pareto efficiency states that any point within the ppf curve is inefficient because the total output of commodities is below the output capacity conversely any point outside the ppf curve is impossible because it represents a mix of commodities that will require more resources to produce than are currently obtainable therefore in situations with limited resources the only efficient commodity mixes lie along the ppf curve with one commodity on the x axis and the other on the y axis an economy may be able to produce all of the goods and services it needs to function using the ppf as a guide however this may lead to an overall inefficient allocation of resources and hinder future growth when the benefits of trading with other countries are considered | |
what are the 3 assumptions of the production possiblity frontier | there are four common assumptions in the model | |
what is the importance of the production possibility frontier | the ppf demonstrates whether resources are being used efficiently and fully when everything else remains constant thus the variables can be changed to see how the curve reacts letting you observe different outcomes | |
how do you calculate the production possibility frontier | the simplest method is to use excel or google sheets fill two columns with two variable values highlight the data and use the chart wizard create an xy scatter plot chart and label the x and y axes | |
what is the purpose of the production possibility frontier in economics | because the ppf is a curve based on the data of two variables representing resources between two goods the data can be manipulated to observe how scarcity growth inefficiency efficiency and other factors can affect production | |
why is the production possibility frontier called the opportunity cost curve | the ppf identifies the options when making a decision when you decide on one action you lose the opportunity that the other action provides thus there is an opportunity cost the ppf curve plots this the bottom linethe production possibility curve illustrates the maximum possible output for two products when there are limited resources it also illustrates the opportunity cost of making decisions about allocating resources businesses and economists use the production possibility frontier ppf to consider possible production scenarios by changing resource variables the ppf allows businesses to learn how variables influence production or decide which products to manufacture economists can use it to learn how much of a specific good can be produced in a country while not producing another good to analyze economic efficiency levels and growth | |
what is productivity | productivity is a measure of performance that compares the output of a product with the input or resources required to produce it the input may be labor equipment or money the u s government focuses on labor productivity economic productivity is calculated as a ratio of gross domestic product gdp to hours worked labor productivity is analyzed by sector to identify trends in job growth wages and technological advances in the business world productivity is a measure of the efficiency of a company s production process it is calculated by measuring the number of units of a product produced relative to labor hours or by measuring net sales relative to labor hours corporate profits and shareholder returns are directly linked to productivity growth investopedia danie drankwaterunderstanding productivityeconomists see productivity as the key source of economic growth and competitiveness whether it is being measured in a business an industry or a nation a country s ability to improve its standard of living depends on its ability to raise its output per worker this does not necessarily mean that every worker works harder it means that some combination of improvements in equipment the production process and the work environment enables workers overall to increase their production economists use productivity growth to model the productive capacity of economies and determine their capacity utilization rates this in turn is used to forecast business cycles and predict future levels of gdp growth in addition production capacity and utilization are used to assess demand and inflationary pressures 4 types of productivity measuresthe most commonly reported productivity measure is labor productivity published by the bureau of labor statistics this is based on the ratio of gdp to total hours worked in the economy labor productivity growth comes from increases in the amount of capital available to each worker called capital deepening the education and experience of the workforce labor composition and improvements in technology multi factor productivity growth 1however productivity is not necessarily a reliable indicator of the health of an economy at a given point in time for example during the 2009 recession in the united states output and hours worked were both falling while productivity was growing that is hours worked were falling faster than output 2gains in productivity can occur both in recessions and in expansions as it did in the late 1990s so one needs to take economic context into account when analyzing productivity data 3many factors impact a country s productivity investment in plant and equipment innovation improvements in supply chain logistics education enterprise and competition all effect productivity the solow residual which is usually referred to as total factor productivity measures the portion of an economy s output growth that cannot be attributed to the accumulation of capital and labor it is interpreted as the contribution to economic growth made by managerial technological strategic and financial innovations also known as multi factor productivity mfp this measure of economic performance compares the number of goods and services produced to the number of combined inputs used to produce those goods and services inputs can include labor capital energy materials and purchased services 4capital as a productivity measure looks at how efficiently physical capital is being used to create goods or services physical capital includes tangible items such as office equipment labor materials warehouse supplies and transportation equipment capital productivity is calculated by subtracting liabilities from physical capital you then divide the sales number by the difference a higher capital productivity number shows that physical capital is being used efficiently in the creation of goods and services while a lower capital productivity number shows the opposite productivity by materials measures output compared to the amount of materials consumed materials consumed can be heat fuel or chemicals used in the process of creating a product or service it analyzes the output generated per unit of material consumed productivity and investment | |
when productivity fails to grow significantly gains in wages corporate profits and living standards are limited | investment in an economy is equal to the level of savings because investments are financed from savings low savings rates can lead to lower investment rates and lower growth rates for labor productivity and real wages when savings rates in the u s are low it is viewed as harming productivity growth in the future a big question is what role quantitative easing and zero interest rate policies zirp have played in encouraging consumption at the expense of saving and investment for instance during periods of lax monetary policy where credit is accessible and affordable consumers are more likely to incur debt and decrease their savings in pursuit of mortgages loans and other major purchases it is only when monetary policy is tightened and rates rise that the economy encourages saving and ultimately future investment productivity is largely determined by the technologies available and management s willingness and know how to improve processes companies can choose to spend money on short term investments and share buybacks rather than investing in long term capital some economists call for corporate tax reform to better incentivize investment in manufacturing infrastructure or long term assets in the wake of the covid 19 pandemic some economists believe that workers have been focusing more on higher value tasks that rely on technology mobility and scalability as more businesses shift away from strictly on premises operations alternative infrastructure investments are needed to handle a hybrid or fully remote entity | |
how to calculate productivity | the calculation for productivity is straightforward divide the outputs of a company by the inputs used to produce that output the most regularly used input is labor hours while the output can be measured in units produced or sales for instance if a factory produced 10 000 widgets last month while being billed for 5 000 hours for labor productivity would be two widgets per hour 10 000 5 000 sales can also be used as a measure of output in the same factory let s say 10 000 widgets translate into 1 million in sales divide the 1 million figure by 5 000 labor hours to get the productivity number 200 in sales for each hour of labor real world exampleauto manufacturing giant toyota offers a prime example of high end productivity in real life the company had very humble beginnings but has grown to become one of the largest and most productive car manufacturers in the world its toyota production system tps is one of the main reasons for that 5tps includes a few of the following principles by enacting tps practices in its manufacturing every day toyota ensures the company is continually improving and operating at a high standard while resources are not being lost | |
what are the 4 essential components of productivity | productivity can be measured for an individual the four essential components of individual productivity include 1 strategy or the ability to plan 2 focus or the ability to pay attention to one task at a time 3 productive choosing or the ability to choose the most important tasks and make the right choices and 4 consistency the ability to work at a consistent pace and incorporate all of the above in your tasks | |
what is productivity in the workplace | productivity in the workplace refers simply to how much work is done over a specific period depending on the nature of the company the output can be measured by customers acquired phone calls made and of course sales closed an overarching goal of a company should be to maximize productivity without sacrificing product quality and while being efficient with company resources | |
how can i improve my personal productivity | some basic ways to increase personal productivity on a daily basis include | |
what factors affect productivity | in the workplace factors that affect productivity include compensation work environment training career development opportunities wellness diversity increased responsibility and management quality | |
how do i demonstrate productivity at work | ways to show productivity at work are setting goals focusing on one task at a time meeting deadlines being on time taking breaks focusing on the largest tasks first blocking out your calendar having productive meetings and delegating tasks the bottom linethe concept of productivity is simple at a given level of input there is a given level of output more productive societies and processes will yield more output at the same level of input whether it is viewed from an economic standpoint a company standpoint or a personal standpoint being able to measure and track productivity is crucial to long term success |
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