What Is Capacity Utilization?

By Team TranZact | Published on Mar 5, 2023

Every nation and its manufacturing enterprises depend on the knowledge of what is capacity utilization to derive a pattern of production that is proportional to their capability and resources. By utilizing the resources or capacity available at a given time in an optimum manner, enterprises can truly succeed better. Capacity utilization is used in the context of an economy and enterprise.

In this article, we will understand what is capacity utilization, its need, how to calculate it and make use of it. We have also shed some light on capacity utilization in the manufacturing industry. Read to know more about this subject.

What Is Capacity Utilization?

Capacity utilization is an important metric that manufacturing businesses use to calculate and evaluate if they are using their resources in the best possible way to get the desired outcome within a certain period. It is also used by economies to know how efficiently industries are running. These evaluations are also used to work on the fiscal policies of the country at large.

Capacity utilization gives a clear picture of a company's productivity quotient or production potential. If it is low the companies must take suitable measures to become profitable.

Capacity Utilization Formula

Now that you know what is capacity utilization, you can use the capacity utilization rate formula to measure your total available production capacity that is being used to produce goods or services in comparison to its maximum potential. It is expressed as a percentage.

It helps to improve your output by finding ways to use the resources in the best possible manner. Successful manufacturing industries contribute significantly to a nation's economy and thus they must take suitable measures to get the best outcome for greater growth and profit.

For this, they use the following capacity utilization formula.

Capacity Utilization = (Actual Output Level / Potential Output) x 100

Here the output level means the number of items or units a company or an economy can manufacture in a certain time frame. In other words, using this formula for utilization, one can calculate the maximum production capacity of a company or country.

Capacity Utilization Example

Industries need to use the available resources optimally to increase their utilization rate for potential growth. Here is an example to understand capacity utilization better. Suppose there is a manufacturing unit that is currently producing 30,000 units of products in their manufacturing units. But in terms of resources, they have a capacity of producing 60,000 units at the same time.

In this example, this industry has a capacity utilization rate of 50% as calculated below.

Capacity Utilization = (Actual Output Level / Potential Output) x 100 Capacity utilization = (30,000 / 60,000) x 100 = 50% For a 100% utilization rate of their capacity, companies need to use their resources to the best of their potential.

In another example, suppose a company produces 10K units for 50,000 rupees. But with their capacity and available infrastructure, they can produce around 15k units, without increasing the cost of 50 rupees per piece.

Here, the company is not working at its 100% capacity utilization and thus has an opportunity to improve the rate.

How to Calculate Capacity Utilization Rate?

Industries need to evaluate their rate of capacity utilization using the capacity utilization formula. Using this information, manufacturers determine how to enhance the efficiency of their production unit while reducing costs. To calculate, you need to follow these steps-

First, you need to know the level of actual output. You calculate this annually or for a specific period of the year.
Next, you need to calculate the potential output level of your company. It is the maximum possible capacity of the manufacturing unit.
Proper sustainable operation with the full capacity of the company can help boost sales and revenues, as well as impact production outputs. You can examine the sales goals and get details about the potential output you are looking for. You need to then divide the actual output by the potential production or output of that particular company.
Next, the result of the above division must be multiplied by 100 to get the exact utilization rate in percentage.

Capacity utilization rate is a crucial metric for businesses to measure the efficiency of their production processes. It represents the percentage of the maximum output that a company can produce compared to the actual output produced over a specific period. A high capacity utilization rate indicates that a company is effectively using its available resources to produce its goods or services, while a low rate suggests that resources are being underutilized.

Calculating capacity utilization rate involves two main components: actual output and maximum output capacity.

Actual Output: Actual output is the number of goods or services that a company produces during a specific period. This can be measured in terms of units, volume, or any other relevant metric. Actual output is typically measured over some time, such as a day, week, month, or quarter.

Maximum Output Capacity: Maximum output capacity is the maximum amount of goods or services that a company can produce within a given period. This is typically based on the company's resources, such as the number of employees, machines, or facilities available for production. Maximum output capacity can be measured in units, volume, or any other relevant metric.

In addition to the above formula to calculate the capacity utilization rate, you can also arrive at this metric by dividing actual output by maximum output capacity and then multiplying the result by 100 to express it as a percentage.

Importance of Capacity Utilization Rate

It is often thought that if a manufacturing plant is producing goods using its 100% capacity, it is doing great in terms of production efficiency.

However, the truth is that optimal capacity utilization lies somewhere between excessive and minimal production. 100% production capacity means high pressure on resources and increased bottlenecks resulting in inefficiency.

Again, if a production unit is producing goods at 40% or 50% of its capacity, it would lead to unused resources. So, usually, 80% and 85% capacity utilization is considered ideal as it ensures that there are resources to manufacture any items that have issues.

Understanding Capacity Utilization in Manufacturing

Understanding production capacity utilization is important for manufacturing businesses and economists. It offers a lens through which the potential production capacity can be evaluated well. This metric not only provides insights into a company's operational prowess but also responds dynamically to market and consumer demands.

Historically, institutions like the U.S. Federal Reserve have been tracking and publishing capacity utilization rates, offering a macroeconomic perspective since the 1960s. For most businesses and economic operations, a capacity utilization rate hovering between 85% and 100% is deemed optimal.

How Capacity Utilization Affects Economies?

Capacity utilization is something that economists analyze regularly to know if businesses are making the best use of their manufacturing resources and contributing to the economy as they should.

If an economy has a low capacity ratio (much lower than 100%), it can increase production without incurring any additional cost. When resources in an economy are not allocated effectively, it cannot function at an ideal capacity of 80-85%.

The capacity utilization of an economy indicates its growth of an economy. A high rate means the economy is going strong and GDP is increasing while low capacity utilization indicates the reverse i.e. economic condition is not good.

High capacity utilization leads to inflation high demand and low rate results in deflation with low demand and surplus goods. Economies with high capacity utilization attract investors who think of high efficiency as a key factor that makes a business investable. It also increases job opportunities as production houses need more people for more production.

Corporate Capacity

Corporate capacity means the company's ability to undertake activities that are necessary for achieving its goals. It is the sum of all resources, such as financial, physical, and human capital, that can be used to support a company's operations. It helps to know operational efficiency and cost per unit along with the company's cost structure.

Corporate capacity helps businesses take on new projects and grow as a business. Companies must ensure they have adequate corporate capacity to remain competitive in the market and scale further.

Effects of Low Utilization

Low utilization of resources is a common problem faced by businesses today. Low utilization can impact the productivity and efficiency of a manufacturing unit thereby decreasing profits. It also leads to low morale as well as employee productivity. Some reasons for this are a lack of skilled and motivated employees and inefficient processes.

Low utilization can also put pressure on resources, as too many resources are allocated for tasks that do not require them. Therefore, organizations need to monitor and manage their utilization levels to maximize productivity and efficiency.

Improve Capacity Utilization, Improve Profits

The rate of capacity utilization of every industry provides complete data about its economic and operational activeness. Such evaluation also helps industries to use their resources better.

Fortunately, there are steps that businesses can take to address low utilization and increase their utilization rate. They can implement changes, such as better scheduling, production planning, staff training, and incentives for employees. Using various technologically advanced tools like TranZact's Cloud-ERP functionalities, you can easily streamline processes and increase efficiency.

FAQs

1. What is good capacity utilization?

For successful economic and operational ventures, 85-100% capacity utilization rate is good capacity utilization.

2. What is the KPI of capacity utilization?

The KPI or key performance indicators are the areas that help to gauge capacity utilization in the manufacturing industry. Some KPIs of capacity utilization are resource utilization, productivity, total output, investment, and cycle time.

3. What factors affect capacity utilization?

Some factors affecting capacity utilization are capital and labour. Both these are elements of unit production and hence largely affect the capacity utilization ratio. These are the basics of manufacturing units that cannot operate without both of these.

4. Why is it important to maintain an optimal capacity utilization rate?

Maintaining an optimal capacity utilization rate ensures that resources are used efficiently, leading to cost savings and maximizing production without overburdening the system.

5. How does capacity utilization impact the overall economy?

A high capacity utilization rate indicates a thriving economy with industries operating near their full potential, leading to job creation and GDP growth. Conversely, a low rate may signal economic downturns.

6. Can a business operate at 100% capacity utilization all the time?

While it's technically possible, consistently operating at 100% can strain resources and lead to inefficiencies. An ideal rate is often between 80% and 85%.

7. How can technology help in improving capacity utilization?

Technological tools, like Cloud-ERP functionalities, can streamline processes, improve scheduling, and enhance production planning, leading to better capacity utilization.