Definition

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Capacity Utilization Rate

Updated on April 30, 2022

What is capacity utilisation rate?

The percentage of capacity that is used over a given time is known as capacity utilisation. Companies can determine how efficiently they are functioning by tracking capacity utilisation. Firms can use the capacity utilisation rate to measure the efficiency of production facilities and assets of the organisation, both physical and human. Using the capacity utilisation rate concept, the productivity of labour and fixed factors can be assessed over some time, i.e. daily, monthly, quarterly or annually. The capacity utilisation rate is also called as operating rate. The capacity utilisation rate also aids in determining the rate of increase in piece costs. Because things are easier to quantify than services, the capacity utilisation rate is better suited for enterprises that make physical objects rather than services.

Summary

The percentage of capacity that is used over a given period is known as capacity utilisation.
Using the capacity utilisation rate concept, the firm can assess the productivity of labour and fixed factors over a period of time.
The most excellent capacity utilisation rate that firms can predict is only by factoring in that both the man and machine can have problems.

Frequently Asked Questions (FAQs)

How is the capacity utilisation rate estimated?

We know that the potential output of an individual at a software firm is eight working hours over five working days. So the maximum potential output is 40 hours per week. At the end of the week, when actuals are checked, it is found that the employee has clocked 30 hours. Therefore, the capacity utilisation for the employee will be 75% estimated using the formula given below-

To factor in the possibility of outliers, seasonality and human factors, it is fair to assess capacity utilisation rate using data spread over a long time. An instance of an outlier may be a strike, a natural disaster-induced power outage, pandemic etc. Some businesses might have a seasonality factor to be considered while calculating the capacity utilisation rate—for instance, cold beverage businesses in countries with predominantly tropical weather conditions. The maximum potential factory output will be based on the peak season demand, which runs for almost three quarters of a year. However, the factory will be running at a sub-optimal utilisation rate the remaining period given the low demand. Thus employee or capital asset capacity utilisation rate may not be effectively assessed during such lean periods alone. Especially when it comes to human resources, their physical and mental health factors may impact their utilisation over shorter periods. The pandemic COVID 19 caused many employees to fall ill or lose their loved ones. All such one-off cases influence their utilisation.

Is a 100% capacity utilisation rate ideal?

The capacity utilisation rate shows the value of production capacity that is being used over a given period. By offering the output in percentages, it can give a better picture of overall resource utilisation and how well the production firm can do if total output is increased without affecting the firm's cost of production. The capacity utilisation rate cannot surpass 100% since machines break down and humans get exhausted. The most excellent capacity utilisation rate that can be predicted is only by factoring in that both the man and machine can have problems. Various challenges might arise when operating machinery and equipment that prevent firms from getting the best results. Similarly, a worker cannot always give his or her best effort every day.

How can capacity utilisation be enhanced?

Economists use the rate to gauge inflationary pressures. Firms can adopt various measures to achieve this goal- increasing projected production can be accomplished by increasing planned manufacturing. Many new entrepreneurs face the challenge of adapting to rapid changes in production, demand, manufacturing, and so on. When done from the ground up, it always results in efficiency at every level. The two foundations of good operations, including capacity utilisation, are planning and scheduling.

Strategic advancement is critical for business development whenever you seek to start something new. Successful investors seek out companies with well-defined goals and strategic decisions that significantly impact the company's future. Plan should be modest production rates for maximum capital gain. Sharing capacity is becoming more popular as a means of maximising capacity use- both sides because they profit equally. It also improves profitability and cash flow. Another means of enhancing capacity utilisation is sub-contracting, wherein the firm take orders and produce for other businesses. In such a case, there is scope to maximise capacity utilisation and thus profitability too.

Participating in promotional efforts and introducing innovative techniques to boost product value can also lead to a rise in production rate and maximum capacity utilisation. With an increase in product demand, capacity expansion is complex. Paying too much for less output would reduce your profit margins. Thus adapting to demand fluctuations is essential.

How can increasing capacity utilisation benefit the economy as a whole?

Under-utilised capacity affects a company's cash flow, causes tax defaults, disrupts production planning and control, disrupts inventory movement, causes irregularity in debt repayment, and delays wage payments. It severely limits the company's potential to expand through investment. If companies don’t grow, the Gross Domestic Product of the nation may see a decline. Several businesses are unable to develop due to a lack of capital. However, due to a lack of business, existing capacities stay dormant. If current capacity is underutilised in an economy, and new capacity would be built, the economy's productivity would suffer.

What are the economic implications of the rate of capital utilisation?

The rate is used by economists to gauge inflationary pressures. Excess capacity and lack of demand can lead to prices falling. Economies with a high capacity utilisation rate can increase output dramatically without increasing costs. It is of essence to note that regardless of economic conditions, 100% capacity utilisation will never be achieved because inefficiencies in resource allocation will always remain in any economy.

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