Financial Terms
Factor of Production

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Definition of Factor of Production

Factor Of Production Image 1

Factor of Production

A resource used to produce a good or service. The main macroeconomic factors of production are capital and labor.

Related Terms:

ADF (annuity discount factor)

the present value of a finite stream of cash flows for every beginning $1 of cash flow.

PPF (periodic perpetuity factor)

a generalization formula invented by Abrams that is the present value of regular but noncontiguous cash flows that have constant growth to perpetuity.

Amortization factor

The pool factor implied by the scheduled amortization assuming no prepayemts.

Annuity factor

Present value of $1 paid for each of t periods.

Conversion factors

Rules set by the Chicago Board of Trade for determining the invoice price of each
acceptable deliverable Treasury issue against the Treasury Bond futures contract.

Discount factor

Present value of $1 received at a stated future date.


A financial institution that buys a firm's accounts receivables and collects the debt.

Factor Of Production Image 2

Factor analysis

A statistical procedure that seeks to explain a certain phenomenon, such as the return on a
common stock, in terms of the behavior of a set of predictive factors.

Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

Factor portfolio

A well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of
zero on any other factors.


Sale of a firm's accounts receivable to a financial institution known as a factor.

Maturity factoring

factoring arrangement that provides collection and insurance of accounts receivable.

Multifactor CAPM

A version of the capital asset pricing model derived by Merton that includes extramarket
sources of risk referred to as factor.

Net benefit to leverage factor

A linear approximation of a factor, T*, that enables one to operationalize the
total impact of leverage on firm value in the capital market imperfections view of capital structure.

Old-line factoring

factoring arrangement that provides collection, insurance, and finance for accounts receivable.

One-factor APT

A special case of the arbitrage pricing theory that is derived from the one-factor model by
using diversification and arbitrage. It shows the expected return on any risky asset is a linear function of a
single factor.

Pool factor

The outstanding principal balance divided by the original principal balance with the result
expressed as a decimal. Pool factors are published monthly by the Bond Buyer newspaper for Ginnie Mae,
Fannie Mae, and Freddie Mac(Federal Home Loan Mortgage Corporation) MBSs.

Present value factor

factor used to calculate an estimate of the present value of an amount to be received in
a future period.

Production payment financing

A method of nonrecourse asset-based financing in which a specified
percentage of revenue realized from the sale of the project's output is used to pay debt service.

Production-flow commitment

An agreement by the loan purchaser to allow the monthly loan quota to be
delivered in batches.

Reported factor

The pool factor as reported by the bond buyer for a given amortization period.

Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

Two-factor model

Black's zero-beta version of the capital asset pricing model.


A depreciation method that relates a machine’s depreciation to the number of units it makes each
accounting period. The method requires that someone record the machine’s output each year.

Limiting factor

The production resource that, as a result of scarce resources, limits the production of goods
or services, i.e. a bottleneck.

Non-production overhead

A general term referring to period costs, such as selling, administration and financial expenses.

Production overhead

A general term referring to indirect costs.

cost of production report

a process costing document that
details all operating and cost information, shows the computation
of cost per equivalent unit, and indicates cost assignment
to goods produced during the period

critical success factors (CSF)

any item (such as quality, customer
service, efficiency, cost control, or responsiveness
to change) so important that, without it, the organization
would cease to exist

economic production run (EPR)

an estimate of the number
of units to produce at one time that minimizes the total
costs of setting up production runs and carrying inventory

equivalent units of production (EUP)

an approximation of the number of whole units of output that could have been
produced during a period from the actual effort expended
during that period; used in process costing systems to assign
costs to production


The sale of accounts receivable to a third party, with the third party bearing
the risk of loss if the accounts receivable cannot be collected.

Factory overhead

All the costs incurred during the manufacturing process, minus the
costs of direct labor and materials.

Production yield variance

The difference between the actual and budgeted proportions
of product resulting from a production process, multiplied by the standard unit cost.

annuity factor

Present value of an annuity of $1 per period.

discount factor

Present value of a $1 future payment.

Aggregate Production Function

An equation determining aggregate output as a function of aggregate inputs such as labor and capital.


The discounting, or sale at a discount, of receivables on a nonrecourse, notification
basis. The purchaser of the accounts receivable, the factor, assumes full risk of collection and
credit losses, without recourse to the firms discounting the receivables. Customers are notified to
remit directly to the factor.

Lean production

The technique of stripping all non-value-added activities from
the production process, thereby using the minimum possible amount of resources
to accomplish manufacturing goals.

Process flow production

A production configuration in which products are continually
manufactured with minimal pauses or queuing.

Scrap factor

An anticipated loss percentage included in the bill of material and
used to order extra materials for a production run, in anticipation of scrap losses.

Shrinkage factor

The expected loss of some proportion of an item during the
production process, expressed as a percentage.


An agent who buys and sells goods on behalf of others for a commission.


Type of financial service whereby a firm sells or transfers title to its accounts receivable to a factoring company, which then acts as principal, not as agent.

Interest Factor

Numbers found in compound interest and annuity tables. Usually called the FVIF or PVIF.

product cost

This is a key factor in the profit model of a business. Product
cost is the same as purchase cost for a retailer or wholesaler (distributor).
A manufacturer has to accumulate three different types of production
costs to determine product cost: direct materials, direct labor, and
manufacturing overhead. The cost of products (goods) sold is deducted
from sales revenue to determine gross margin (also called gross profit),
which is the first profit line reported in an external income statement
and in an internal profit report to managers.


an increase in units or volume caused by the addition
of material or by factors inherent in the production process

flexible manufacturing system (FMS)

a production system in which a single factory manufactures numerous variations
of products through the use of computer-controlled
focused factory arrangement
an arrangement in which a
vendor (which may be an external party or an internal corporate
division) agrees to provide a limited number of
products according to specifications or to perform a limited
number of unique services to a company that is typically
operating on a just-in-time system


any factory or production cost that is indirect to
the product or service; it does not include direct material
or direct labor; any production cost that cannot be directly
traced to the product

Circular Flow

Income payments to factors of production are spent to buy output. The receipts from these sales are used to pay factors of production, creating a circular flow of income.







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