Overproduction or underproduction? Factories and industries constantly battle these two states when running a business, and this situation always pushes professionals to calculate capacity utilization.
Capacity utilization is an extremely crucial metric that determines a company or factory’s operational efficiency. It’s a great insight for factories to craft strategies that can improve production, market demand, customer needs, and efficient output.
This leads them towards “Optimal Capacity Utilization”, seeking which becomes mandatory for running efficient businesses. And this is what we’re talking about. Optimal capacity utilization is the level where you hit the sweet spot, that fine line that exhibits the lowest variable cost of production and highest rate of quality output.
Logically you would be led to believe that the optimum rate of capacity utilization is 100% but that may not be the most optimal point to operate efficiently.
This article educates you on;
- Capacity Utilization
- Why Should We Calculate Capacity Utilization
- Formula for Calculating Capacity Utilization
- How to Calculate Capacity Utilization
- Example of Calculating Capacity Utilization
- Benefits of Calculating Capacity Utilization
What is Capacity Utilization?
Specific to manufacturing, capacity utilization refers to the metric that refers to the output of a plant or factory. It’s a relative measure of the company’s output to its maximum potential output, typically expressed as a percentage.
This percentage gives you an insight into the plant’s production efficiency, business sales performance and devises strategies for the future, such as optimizing production and tracking efficiency.
Why Do We Need to Calculate Capacity Utilization?
There are several reasons that compel business owners and manufacturers to calculate capacity utilization as it will help them understand many aspects of how their business is performing, for example manufacturing costs, product mix ratios, raw materials consumption and energy use to name a few. .
You might see plants doing extremely well, producing at an unbelievably faster pace. This may portray them as successful, but that not really is the case.
This is listed as one of the most challenging things for companies to understand: when to slow down! Balance is a crucial point for plants to achieve and utilize the resources in the best way.
Meeting customer needs and market demand at an accelerated rate may result in;
- Bottlenecks within the process, warehouse or supply chain
- Wastage of resources, excessive energy use to achieve >100% capacity utilization
- Inefficiency
So? What’s the goal? Finding that sweet spot, serving as a balance between too little and too much!
This isn’t the only scenario that compels manufacturers to calculate capacity utilization. Another reason why it must be practiced is to determine underproduction.
For instance, if a company operates at 40% of its maximum output, it is underproducing and wasting money on unused resources. Again, the business needs to identify that mild, sweeter spot and maintain a balance between over and underproduction.
Formula for Calculating Capacity Utilization
The formula for capacity utilization is pretty straightforward. It’s the ratio of actual output divided by maximum output, multiplied by 100.
Capacity Utilization = ( Actual output / Maximum Potential Output) x 100
How to Calculate Capacity Utilization
Just a few inputs and you’re done. Follow the steps mentioned below to calculate capacity utilization using the formula above.
Calculate Actual Output
This is the first part that needs to be calculated before being put in the formula. It represents the actual production any plant has produced to date or during the specific period for which utilization capacity will be calculated.
Manufacturers maintain proper records of the inventory and later use the same data for calculating the actual output.
For instance, a factory produces 5,000,000 products, this is the actual output for that very year, and this will be put in the formula.
Determine Potential Output Level
Before you determine it, you need to understand what a company’s potential output is.
It’s a factory or manufacturing plant’s complete capacity to utilize its resources completely. It happens when a plant operates at its full nameplate capacity.
For example, the potential output level of a plant is 8,000,000. This is the number that represents the potential output level in the formula.
Divide Actual Output by Potential Output
At this stage, you will have both the values calculated and in hand. So, you simply have to divide actual output by potential output.
Multiply Quotient by 100
The number you get after dividing the actual output by the potential output is the quotient.
Multiply it by 100 to get the percentage that will represent the utilization capacity.
Example of Calculating Capacity Utilization
To understand the concept in a better way, let’s work out an imaginary scenario, and calculate the capacity utilization. It’s better to refer to the values concluded above.
For instance;
Our actual output was: 5,000,000
The potential output level was: 8,000,000
Let’s put the values in the capacity utilization formula.
Capacity utilization = (Actual Output/ Potential Output) x 100
Capacity utilization = (5,000,000/ 8,000,000) x 100
Capacity utilization = (0.625) x 100
Capacity utilization = 62.5%
So, the capacity utilization is assumed manufacturing plant is 62.5%
Benefits of Capacity Utilization
This strategy is far more optimistic than just determining the output. Here’s the list of the benefits.
| Increased Efficiency | Manufacturers learn how to get the most out of their resources |
| Budget-Friendly / Cost-Saving Practice | With this, producing more without any other investments actually cuts costs. |
| Higher Profit Margin | More production leads to accelerated growth, sales, and profit margins. |
| Better Resource Management | Accurate and full use of resources and labor prevents wastage and mismanagement. |
| Customer Satisfaction | Optimal and consistent productions enable manufacturers to meet the market demand and satisfy customers. |
| Improved Planning | Knowing the exact scenario, available resources, and different levels helps manufacturers plan future expansions more efficiently. |
| Calculating Revenues | Capacity utilization is a better way to gauge the financial condition and plan future investments and expansions. |
FAQs
How often should a plant calculate its capacity utilization?
Calculating capacity utilization monthly or quarterly is the best practice. By doing so, manufacturers can continuously monitor efficiency, identify the needed improvements, and make necessary arrangements to align the manufacturing process swiftly.
Are there any factors affecting a plant’s utilization rate? If yes, please mention them.
Yes, there are factors that affect a plant’s capacity utilization. These include equipment maintenance & downtime, labor availability, supply chain disruptions, and fluctuations in market demand. Manufacturers must always keep an eye on these factors to maintain optimal capacity utilization.
Can we improve capacity utilization without major investment?
Yes! Investing in better scheduling, enhanced training workshops for workers, preventive maintenance, and optimizing the current processes can definitely improve the overall capacity utilization.
Conclusion:
Capacity utilization is a measure of the ratio of a plant’s actual output to the maximum potential output multiplied by 100. Calculating capacity utilization helps manufacturers determine the balance between under and overproduction, which is crucial for optimal production efficiency.
