Why Should We Not Confuse Productivity with Profitability?

Enterprises and industries have measurements to evaluate how well an entity is doing. Some of these measures can be indicators of financial performance (e.g., profitability and return on assets), operational (e.g., productivity and efficiency) or other qualitative and quantitative measurements of performance, such as quality of product/service or retain customers.

Coming to draw the borderline between profitability and productivity, one must make it clear that while the first is a measurement of financial performance (stated in currency, although profitability rates are also in use), the latter is a general term which refers to many ratios we can make in the output/input system with various types of inputs.

Profitability measures the degree of success or failure of a given enterprise or division for a period.

Profitability can be measured in different ways – in accounting there are several ratios that measure productivity – profit margin on sales (measures net income generate by each dollar of sales), rate of return on assets (measures overall profitability of assets, rate of return on common stock equity (measures profitability of owners’ investment), earning per share (measures net income earned on each share of common stock), price-earnings ratio (measures the ratio of the market price per share to earnings per share), payout ratio (measures percentage of profits distributed in the form of cash dividends. Profitability is a measured by income statement and is one of the most important signs of success of a company.

Productivity measures how much output is produced per unit of input. For example, labor productivity measures how much production is generated per hour of work, and machine productivity estimates how much output is produced per piece of equipment a company has. Total productivity can be measured by dividing total output by total input.

Profitability is mainly a financial term and productivity – operational. These two measurements do not necessarily go together, meaning that a company that has high productivity will not undoubtedly be profitable. In a big business, usually a production department will be responsible for reaching as high productivity as possible, and the financial agency is accountable for achieving high profitability.

For example, a company that produces, let’s say, laptop bags may reach high productivity if the production process is organized correctly (short lead time, no idle time, skilled workers with high labor productivity, etc.). If the company is forced to sell its products with low-profit margin, then its profitability most probably will be low, unless a company can produce and sell sufficient amount of laptop bags. A competitor company can produce designer laptop bags with much more average productivity ratio and sell the kits with high-profit margin and as a result, achieve higher productivity.

Both productivity and profitability can be good indicators of how well a company is performing. However, they should be considered only in comparison with the performance of the overall industry and the most significant competitors. Moreover, profitability is usually one of the primary goals of the companies, while optimizing productivity is only a tool to increase profitability.

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