Improving Operational Efficiency Ch22
(Capacity, Scale of operation and Work Study) Capacity
“Capacity is the maximum amount the organization can produce in a given period in shortrun, i.e. without extra fixed assets and/ or fixed overheads”.
Capacity is often difficult to estimate as more output can be produced by a more intensiveuse of plant e.g. motivated work force, better material, better maintenance or shift work.
“Capacity utilization is the extent to which the maximum capacity of the firm is being used,i.e. actual output as a percentage of maximum potential output”.
Actual output per period x 100Full capacity output per period
A firm’s capacity utilization is of considerable financial importance, because of the impactof fixed overheads per unit on profit margins.
A firm has a maximum capacity to produce 100,000 units in a month. There isaverage $ 50,000 fixed cost in a month to the firm.
firm produces 25000 units in amonth, it means that fixed cost per unit will be $ 2.
firm produce 100,000 units at fullcapacity, fixed cost per unit will be $ .5.
high capacity utilization keeps fixed costs per unit down, by spreading the overheadsover many units of output.
Full Capacity Utilization
When firm produced products at maximum capacity level, it is called full capacity utilization.
Sense of job security to the employees
By passing benefit of low fixed cost per unit to the customers, large market segmentcan be targeted.
Increase in profit margin
It can attract investors for further investments.
Work load on staff
Regular customers can be affected
Insufficient time to maintain the machinery
Firm will not be able to meet sudden demand
Excess (spare) capacity exists when the current levels of demand are less then the full capacityoutput of a business.
Spare capacity in short term
– seasonal problemMaintain output level and add to stock but this is risky and expensive. Or adopt moreflexible production methods and machines to produce the other goods.
Spare capacity in long term-
due to change in fashion, technological developments,competitors, economic recession.
Increasing the Scale of Operation
Why a firm wants to increase the scale of operation when they know that it requires huge finance.This happens when firms wants to enjoy the full benefits of large scale production which are calledeconomies of scale.
Economies of Scale