LIMITING FACTOR ANALYSIS

Where there are no constraints, produce all products that give profit/contribution. If
a constraint exists, ration the resource available amongst the products that will
produce the highest contribution despite the limitation.
Examiner can test this analysis under:
1. Key factor analysis using contribution per limiting factor
2. Throughput accounting
3. Linear programming
Both 1 and 2 use similar analysis and they will be the object of my discussion.
Using contribution per limiting factor
1. use only when there is a single constraint
2. follow the below steps
a. identify the limiting factor (labour hours, material, etc)
b. cal. contribution per unit
c. cal. contribution per limiting factor (i.e. contribution/labour hour per unit
assuming labour is the limiting factor)
d. rank according to c above
e. allocate resources and determine the optimum production plan.
Throughput accounting
Concept.
1. In the short-run, only direct material costs are variable. Labour and
overheads (conversion costs) are fixed and are grouped together and called Total
factory costs. (NB: This is the differentiating factor from the conventional method
above where we assume direct material, direct labour and variable o/hs to be
variable costs)
2. In a JIT environment, goods should only be produced when there is demand for
them. This ensures faster time to market. Producing for inventory does not create
sales.
3. Factory spends money when goods are produced. The company makes money
when goods are sold. Overall profitability is determined by the relative rate at which
the company makes money and the rate at which the factory spends money.

*throughput calls constraint bottleneck resource

*throughput means steady, smooth flow of production.
*a bottleneck resource is that factor that will not allow production to flow without
delay.
*In a process, it is the process that will take the longest time that will delay other
processes. Other processes will have to wait for it.
Question 1
The factory has 50 production lines each of which contain the three processes: Raw material
for the sheet metal is first pressed then stretched and finally rolled. The processing capacity
varies for each process and the factory manager has provided the following data:
Processing time per metre in hours
Product A Product B
Product C
Pressing
050
050
040
Stretching
025
040
025
Rolling
040
025
025
Required:
(a) Identify the bottleneck process and briefly explain why this process is
described as a bottleneck. (adapted from F5 June 2009, Q1)
(3 marks)
Solution:
You dont have to do any calculation. By observation, you will see that for product A,
pressing will take the longest time and other processes (stretching and rolling) will have to
wait. The same thing goes for product B and C.
*the process with the lowest output, will be the bottleneck if output is the yardstick.
Format for key factor analysis
PRODUCTS
Selling price
Variable cost/unit
Dm
dl
v. o/hs
Contribution/unit (a)
Labour hour (key factor)/unit (b)
Contribution/labour hour (a/b)
Ranking

A
$
20
10
15

$
400

(45)
355
5hrs
$71
1 st

B
$
30
10
15

$
600

C
$
40
10
20

(45)
555
15hrs
$37
3rd

$
500

(70)
430
10hrs
$43
2nd

Allocation of available resource (total labour hours)

Hours
hrs/unit
units
Product A
5,000
5
1000
Product C
15,000
15
1000
Product B (the remaining hrs if any)
2,000
10
200
22,000
2200

Throughput format
Product A Product B Product C
Selling price
700
600
270
Raw materials
30
25
18
Throughput
670
575
252
Bottleneck hours
050
050
040
Throughput per bottleneck hour* (a)1340
1150
630
Fixed costs per hour (b)
900
900
900
TPAR
149
128
07
Working* 67/05 = 134 575/05 = 115 252/04 = 63.

Decision rule:
Any product(s) with throughput accounting ratio (TPAR) of less than 1, do not produce. HERE
PRODUCT C.
Produce product(s) with TPAR> 1. HERE PRODUCT A AND B.
*Any product with a TPAR<1, the factory is spending more money than the cash the
company is generating from sales.
*TPAR>1, the rate at which cash is generated from sales is higher than the rate at which the
factory is spending money.
*Companies should improve on TPAR<1. How?
Start from sales in the calculation above and follow the table downward.
How to improve TPAR<1
a. increase the selling price(consider competition, increase sales volume)
b. reduce the raw material costs (better negotiation, alternative supplier e.g china products,
etc)
c. design out cost or control fixed costs(use target costing, work on costs drivers, outsource,
etc)
d. reduce bottleneck time.
*when answering questions, give points relevant to the questions. There will always an
answer in the question.
*remember, if TA ratio is <1 close down the product line.
*before you close than consider the following factors
1.
2.
3.
4.
5.
6.
7.

customers perception could be negative

competitors may see opportunity to win or de-market the company
what other profitable use can the company put resources freed up on the product to?
the effect the close than will have on employee morale
the reaction of suppliers that are disproportionately affected.
is the product used to sell other products(complimentary goods)?
accuracy of the assumption made for costs classification, etc.

I love you all.

Now try question no1, june 2009. Discuss your challenges with me here.

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