Capacity Planning

Capacity Planning
• Capacity refers to :
The upper limit or ceiling on the load that an operating unit
(Plant, department, Machine, Store, worker)can handle
• Capacity planning aims to :
Achieve a match between supply capabilities and the
predicted level of demand
• Capacity also includes
– Equipment
– Space
– Employee skills
• The basic questions in capacity handling are:
– What kind of capacity is needed?
– How much is needed?
– When is it needed?

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Reasons of capacity planning
 Examples of Capacity Measures

Type of Measures of Capacity

Organization Inputs Outputs
Manufacturer Machine hours Number of units
per shift per shift
Hospital Number of beds Number of
patients treated
Airline Number of planes Number of
or seats seat-miles flown
Restaurant Number of seats Customers/time
Retailer Area of store Sales dollars
Theater Number of seats Customers/time
 Importance of Capacity Decisions
1. Impacts ability to meet future demands
2. Affects operating costs
3. Major determinant of initial costs
4. Involves long-term commitment
5. Affects competitiveness
6. Affects ease of management
7. Globalization adds complexity
8. Impacts long range planning

5-5
Steps for Capacity Planning
 Various Capacities

• Design capacity
– Maximum obtainable output
• Effective capacity, expected variations
– Maximum capacity subject to planned and expected
variations such as maintenance, coffee breaks,
scheduling conflicts.
• Actual output, unexpected variations and demand
– Rate of output actually achieved--cannot exceed
effective capacity. It is subject to random disruptions:
machine break down, absenteeism, material
shortages and most importantly the demand.
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 Efficiency and Utilization

Actual output
Efficiency =
Effective capacity

Actual output
Utilization =
Design capacity

8
 Efficiency/Utilization Example
for a Trucking Company
Design capacity = 50 trucks/day available
Effective capacity = 40 trucks/day, because 20% of truck capacity goes
through planned maintenance
Actual output = 36 trucks/day, 3 trucks delayed at maintenance, 1 had a flat
tire

Actual Output 36 units / day

Efficiency    90%
Effective Capacity 40 units / day
Actual Output 36 units / day
Utilization    72%
Design Capacity 50 units / day

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 Determinants of Effective Capacity
• Facilities (size, location, layout, heating, lighting, ventilations)
• Product and service factors (similarity of products)
• Process factors (productivity, quality)
• Human factors (training, skills, experience, motivations,
absentation, turnover)
• Policy factors (overtime system, no. of shifts)
• Operational factors (scheduling problems, purchasing
requirements, inventory shortages)
• Supply chain factors (warehousing, transportation,
distribution)
• External factors (product standards, government agencies,
pollution standard)
 Forecasting Capacity
Requirements
• Long-term vs. short-term capacity needs
• Long-term relates to overall level of
capacity such as facility size, trends, and
cycles
• Short-term relates to variations from
seasonal, random, and irregular
fluctuations in demand

5-11
Some Possible Growth/Decline Patterns

Volume

Volume
Growth Decline

0 Time 0 Time

Cyclical Stable

Volume
Volume

0 0
Time Time
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 Developing Capacity Alternatives

• Design flexibility into systems,

– modular expansion
• Take a “big picture” approach to capacity changes,
– hotel rooms, car parks, restaurant seats
• Differentiate new and mature products,
– pay attention to the life cycle, demand variability vs.
discontinuation
• Prepare to deal with capacity “chunks”,
– no machine comes in continuous capacities
• Attempt to smooth out capacity requirements,
– complementary products, subcontracting
• Identify the optimal operating level,
– facility size
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 Outsourcing: Make or Buy
• Outsourcing: Obtaining a good or service from
an external provider
• Decide on outsourcing by considering
– Available capacity
– Expertise
– Quality considerations
– The nature of demand: Stability
– Cost
– Risk: Loss of control over operations with outsourcing;
loss of know-how. Loss of revenue.

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 Evaluating Alternatives: Facility Size

Production units have an optimal rate of output for minimal cost.

Average cost per unit

Minimum
cost

0 Rate of output
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Evaluating Alternatives: Facility Size

Minimum cost & optimal operating rate are

functions of size of production unit.
Average cost per unit

Small
plant Medium
plant Large
plant

0 Output rate
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 Planning Service Capacity

• Need to be near customers

– Capacity and location are closely tied
• Inability to store services
– Capacity must me matched with timing of demand
• Degree of volatility of demand
– Peak demand periods

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Example: Calculating Processing Requirements

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## 33 77 00 00 22 . .00 11 , ,44 00 00
55 , ,88 00 00

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Cost-Volume Relationships

F C
+
Amount ($)

VC C)
=
st t (V
s
co co
t al l e
o i a b
T ar
l v
t a
To
Fixed cost (FC)

0
Q (volume in units)

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Cost-Volume Relationships

ue
en
Amount ($)

rev
tal
To

0
Q (volume in units)

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Cost-Volume Relationships: Break-even analysis

i t
ue f
Amount ($)

n P ro
ve P=
re
t al ost
To t al c
To

0 BEP units
Q (volume in units)
P  (Quantity)(Contribution To Margin)  (Fixed cost)  Q( R  v)  FC
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Break-Even Problem with Multiple Fixed Costs

C =
+ V
FC
TC
= TC
V C
+
FC 3 machines
T C
C =
V
C + 2 machines
F

1 machine
Quantity
Fixed costs and variable costs.
Thick lines are fixed costs.
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Break-Even Problem with Step Fixed Costs
TR

TC

No break
even points Break even
in this range points.

Quantity
Step fixed costs and variable costs.
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 Cost-Volume(Break-even) Analysis

• Break-even quantity: Level of production that

equates total costs to total revenues

Assumptions:
• One product is involved
• Everything produced can be sold
• Variable cost per unit is the same with volume
• Fixed costs do not change with volume
• Revenue per unit constant with volume
• Revenue per unit exceeds variable cost per unit

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Cost Volume Profit Analysis
 Definition
• Cost is a kind of expenditure to produce
goods and services which can be
calculated as under
– Total cost = variable cost + Fixed cost
• Volume is the total no of qty. to be
produced.
• Profit is the difference between sales and
total cost.
• CVP analysis deals about the relationship
between sales, total cost and profit. Some
of the calculations can be done as below :
1.Total cost = Fixed cost + Variable cost
2.Contribution margin= Sales – Variable cost
3.Contribution margin per unit = selling price
per unit – variable cost per unit
• 4. profit volume ratio = Sales – variable cost
Sales
Or,
1 – v/s
5. Break Even point = fixed cost/CMPU
……. Unit
Or,
FC/Pv ratio
Rs…..
• BEP Rs. = BEP unit x sppu
6. Margin of Safety = Actual sales – BEP sales
7. Margin of safety ratio = MOS/sales
8. Required sales for desired profit
FC + DP
CMPU
…………. Unit
FC + DP
P/v ratio
Rs.,,,,,,
• Required sales for desired profit after tax
FC + DP/1-t
S-V
……………… unit
Required sales for desired profit after tax
FC + DP/1-t
Pv ratio
Rs ……………..
• Required sales for desired profit(per unit
profit)
= FC/Sppu-vcpu – ppu
Profit volume ratio = 1 – variable cost ratio
Variable cost= Sales x variable cost ratio
Example
•A company has Rs. 100000 fixed cost,
variable cost per unit Rs. 100 and selling cost
per unit Rs. 150 Calculate
– Pv ratio
– BEP
– Required sales to earn Rs. 50,000
– Required sales to earn Rs. 50,000 after tax
40%
• Given,
Fixed cost = Rs. 1,00,000
Selling price per unit(sppu) = Rs. 150
Variable cost per unit = Rs. 100
Here,
P/V ratio = 1- v/s
1-100/150
= Rs. 0.33 or 33%
• Break Even point = Fixed cost/S-V
100000/150-100
= 2000 unit
= 2000 x 150
Rs. 300,000
Required sales for desired profit Rs. 50,000
= FC + DP
CMPU
100000+ 50,000
150-100
= 3000 unit
= 3000 x 150
= Rs. 450000
Required sales for desired profit after tax
FC + DP/1-tax
S-V
• = 100000 + 40,000/1-0.4
150 – 100
= 3333 unit
= Rs. 3333.33 x 150
= Rs. 499,999
Class work
•A company has Rs. 150000 fixed cost,
variable cost per unit Rs. 170 and selling cost
per unit Rs. 125 Calculate
– Pv ratio
– BEP
– Required sales to earn Rs. 50,000
– Required sales to earn Rs. 50,000 after tax
40%
 Summary
• Capacity types
• Efficiency, utilization
• Break-even analysis

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