When it comes to business operations and measuring performance, the optimal production scale a company can sustain is an important metric to measure. If a business’ capacity can’t be realized and sustained – or the bottlenecks can’t be identified and addressed in a timely manner – a business will likely stagnate and fail. Understanding more about capacity management can help businesses reduce the chances of dealing with sub-optimal performance.
A business’ capacity is defined as its highest level of production on a consistent basis. By measuring the capacity of a business, we can calculate its ongoing revenue projections. This type of evaluation also can help a company determine how to manage production snarls and identify ways to increase capacity reserves to help it manage abnormally high production demands.
Capacity Utilization Rate Defined
This ratio is the percentage of a business’ production capacity that’s currently utilized. If an organization has a capacity utilization rate of 60 percent, the firm is currently operating at 60 percent of its theoretical capacity. When it comes to analyzing a business, this percentage can determine how much capacity may be available for spikes in demand.
This is calculated by taking the actual output and dividing it by theoretical output, with the result multiplied by 100, or as follows:
(actual output/theoretical output) x 100 = capacity utilization rate
Activity Capacity Overview
Activity capacity assesses the scale of production of a particular task over a given time frame (a quarter, six months, or a 12-month fiscal year) while accounting for regular production factors. Common facets of production that affect output include worker rest periods, equipment upkeep, crew swaps, etc. This investigation allows a business to determine if it can accomplish projected production in the near term with existing equipment or if the business needs to analyze bottlenecks before reassessing.
This method is used to approximate the manufacturing quantity scheduled for subsequent time frames. Criteria that’s analyzed for the plan hinges on forecasted market demand, resource availability and production capabilities. It’s an imperative consideration that impacts sales forecasts, indirect operational budgets, and the direct production budget.
Depending on the type of business, budgeted capacity can be represented in either hours or units. For example, a company would evaluate industry and economic demand trends, along with the time frame it’s trying to forecast and what resources the business has available for production. The following steps are commonplace during this process:
- The business plans to produce 480,000 widgets for the projected time frame.
- The business looks at how many shifts will be run, how much each shift can produce, how many days the company will operate, and the number of hours available for production for each shift. This will help the company determine production and resource availability for the projected time frame.
- The business will look at what it’s able to produce based on its full capacity:
- Potential per shift = 100 widgets per hour x 8 hours a shift x 1 shift = 800 widgets
- Potential per day = 800 widgets per shift x 3 shifts per day = 2,400 widgets
- Annual production = 2,400 widgets per day x 275 working days per year = 660,000 widgets
The budgeted production of 480,000 widgets annually is approximately 73 percent of the business’s total production capacity. This leaves the business with ample room to respond to new clients and/or increased demand from existing clients for unexpected orders.
While each business is unique, taking steps to analyze and make more educated projections is one way to increase a company’s efficiency.