What Is Capacity Utilization?

(And How To Calculate It)

November 17, 2021

By: Indeed Editorial Team

Capacity utilization is an important metric that professionals and economists use to determine how
efficiently businesses, organizations and economic entities use resources to produce outputs. Its
calculated rate can tell much about a company’s operational efficiency. In this article, we explore what
capacity utilization is, how to calculate its rate and why it's an important metric for gaining insight into
corporate and economic operations.

Related: What Does an Economist Do? Duties and Work Environment

Key takeaways

 Capacity utilization measures if a company or economy is achieving its full production potential.

 National economists may use capacity utilization results to adjust fiscal or monetary policies.

 Most companies and economies strive for a capacity utilization between 85% and 100%.

What is capacity utilization?

Capacity utilization represents the production or manufacturing capabilities that an economy or

company uses to create output. It's an important ratio that measures the proportion of potential output
to the actual realized output. Capacity utilization results in a percentage that gives insight into a
company's operational efficiency and can fluctuate based on consumer and market demand.

National economists use capacity utilization rates to track how industries are doing in a current
economic environment. For example, the U.S. Federal Reserve has published rates for the United States
economy since the 1960s. Leaders may adjust their monetary or fiscal policies in response to their
findings.

Related: Economic Demand: Definition, Determinants and Types

Capacity utilization rate formula

The capacity utilization formula gives you the capacity utilization rate:

Capacity utilization = (actual output level / potential output) x 100

In the formula, the actual output level represents the number of units a company or economy produces
within a specific period. The potential output represents the maximum capacity that companies and
economies can operate at when they use all resources without incurring more operational expenses.

Related: Break-Even Formula: How To Calculate a Break-Even Point (With Example)

How to calculate capacity utilization

To calculate capacity utilization rate, use the formula capacity utilization = (100,000 / potential output)
x 100 and follow the steps below:

1. Calculate the level of actual output

During specific accounting and reporting periods, a company records the number of products it
completes. This value represents the level of actual output in the formula and includes the total number
of completed inventory.

For instance, a manufacturing company that produces bicycle tires can calculate the total output by
finding the number of bicycle tires it manufactured and sold during the given period. Assuming the
company produces 100,000 tires, it would represent this as the actual output level in the formula:

Capacity utilization = (100,000 / potential output) x 100

2. Determine your potential output level

The potential output represents the maximum level of operational capacity when a company fully uses
its resources. Operating at full capacity in sustainable ways can positively affect production output, sales
and revenues.

Find the potential output by evaluating sales goals and identifying the number of products necessary to
reach those goals. This value is likely your potential output level.

Using the previous example company, assume the potential output level is 225,000. This means the
company is confident that it can produce more than double its current output if it applies all of its
available resources. Use this value in the formula:

Capacity utilization = (100,000 / 225,000) x 100

3. Divide actual output by potential output

Once you calculate your actual output and estimate your potential output level, divide the actual output
by the potential output. Using the previous examples in the formula, divide the two output values:

Capacity utilization = (100,000 / 225,000) x 100 = (0.44) x 100

4. Multiply your result by 100

The result you get after dividing your output values gives you a decimal value that you need to multiply
by 100 to convert into a percent. This percent represents the capacity utilization rate:

Capacity utilization = (100,000 / 225,000) x 100 = (0.44) x 100 = 44%

The capacity utilization rate for the example company is 44%.

5. Interpret your results

When you get the capacity utilization rate, you can interpret the value based on the notion that 100% is
full operational capacity. If the capacity utilization rate is less than 100%, it indicates companies are
operating at less than full capacity. Rates above 100% indicate operations are over capacity.
Typically, a capacity utilization rate between 85% and 100% is acceptable for most economic and
corporate operations. The example rate of 44% shows that the company is operating significantly below
full capacity by underutilizing its resources, inefficiently allocating resources or needing to improve
productivity.

Related: How To Calculate Ratios (With Example)

Importance of the capacity utilization rate

Understanding the capacity utilization rate is extremely important for companies and entire economies
because it allows a foundation for planning the use of resources to produce the highest quality goods.

The capacity utilization rate also gives insight into how well companies and economies maximize
revenue and profits while meeting increasing product demands. Additionally, planning for capacity use
requires knowledge of market demand and how it affects operational capabilities and current processes.

It's also important to note that the capacity utilization rate provides valuable information into the
efficiency of a company's or economy's operational processes. For instance, a capacity utilization rate
that is less than 85% can indicate a need for improvement in production methods, staffing or another
aspect of business applications. Conversely, if a company operates significantly higher than full capacity,
it could risk depleting its resources too quickly.

Related: Supply and Demand: Definition and How It Works

What can you do about a low capacity utilization rate?

To boost capacity and output when your calculation produces a low capacity utilization rate, you can:

 Make strategic decisions about what products to increase in production, which surplus
resources to use in production and how the output meets market demand.

 Make small increases in product output as demand increases and track operational costs to
ensure adequate financial coverage.

 Plan manufacturing schedules and identify deadlines for reaching important production quotas.

 Share capacity rate with other owners that have similar production, revenue and profit goals to
increase capacity and resource utilization.

 Consider subcontracting where your organization takes on contracts and production orders for
other businesses, resulting in increased profits and productivity.

 Improve resource allocation methods through strategic planning, eliminating outdated

resources and ensuring efficient use of current resources.