Capacity UtilizationDefined along with Formula & How to Calculate
What is Capacity Utilization
Capacity Utilization is the measure of how nations or enterprises utilize their production and manufacturing capabilities given a set period of time.
It measures the output given only the resources available and the output should the nation or enterprise use its full capacity.
It can be used as a monitoring tool if there is a need to improve a product, or how to increase one’s production output but still maintain or minimize its cost.
Another name for capacity utilization is operating rate.
The Formula for Capacity Utilization
To compute capacity utilization, the formula used is:
Example of Capacity Utilization
ABC Company plans to produce 30,000 toy cars and the full capacity of its manufacturing operation is 50,000 toy cars.
Given these information, the capital utilization rate is 60% [(30,000/50,000)*100].
A 100% full capacity is achieved when all the resources of the company are utilized.
A lower utilization rate indicates that the firm has a surplus or excess capacity situation.
Fully capacity will not always be achieved because of some internal and external factors that may prevent production from performing to its 100% capacity.
Examples of factors that can prevent this from happening are a breakdown of machines, shortage of supplies, etc.
The considered optimal capacity utilization rate is 85%.
This method is widely used by manufacturing companies because it is easier to quantify products rather than services.
Economic Significance of Capacity Utilization
The capacity rate is directly proportional to the effect of demand in the market.
If the demand goes high, the capacity utilization rate will also increase, and the same goes if demand is slow.
Another use of this rate is to give an indication of the inflation status of a certain country.
With the rate of capacity utilization decreasing, the prices will also decrease due to the excess supply in the market resulting in lower demand.
Closer to 100% capacity rate in an economy may positively affect production without any additional costs.
One of the negative impressions of capitalism is brought by the determined excess capacity in production which results in unallocated resources.
But in almost all cases, the production stage will always experience inherent factors that may prevent it from performing to its full capacity.
The capacity utilization rate can also be considered by the company as a tool for measuring the efficiency rate of its operations.
This may also be used as a guide in the determination of the cost structure of their product(s).
For example, an item’s cost per unit can be monitored and companies will be able to determine how the cost prices fluctuate.
An increase in production will inversely decrease the average cost of production.
An advantage any company will achieve over its competitors is by having a higher capacity utilization rate because this will result in a lower production cost.
For this reason, companies always strive to achieve as near the full capacity rate as possible.
While it is impossible to attain a 100% capacity rate, there are some ways to get close to it.
The following are the measures a company can take to achieve it:
- Increase manpower and implement a premium on working additional hours per day to achieve the daily target production.
- An efficient and effective timetable in production rate over the maintenance of its equipment.
- Hire subcontractors to complete some of the production activities.
Effects of Low Utilization
Lawmakers and monetary policymakers consider the low utilization rate as a big hindrance in attempting to stimulate a country’s economy.
Many European countries were affected by this low rate in 2015 and 2016 as a result of low capacity utilization which eventually resulted in high unemployment and economic slack.
An increase in demand for production will not materially affect the production cost per unit.
There is no need for additional funding to reach the optimum level of production.
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Brookings "Capacity Utilization: Concept, Measurement, and Recent Estimates" White paper. August 4, 2022