Capacity utilization

Capacity utilization

• measures a firm’s output level as a percentage of its potential output.

• It is a measure of a firm’s efficiency as it reveals the extent there are idle resources. 

• High-capacity utilization is financially important as it spreads out fixed and indirect costs of production over a large level of output.

Capacity utilization rate (formula)

(actual output / productive capacity) x 100

Capacity utilization rate (def)

measures a firm's actual output as a percentage of its capacity

ADVs of high capacity utilization rate

• High fixed costs: HCU reduces the average fixed costs as fixed costs will be distributed across a higher number of units produced 

• Low profit margin: products with low profit margins contribute little (per unit) to the profits of a business so need to sold in large quantities to be profitable 

• High levels of break-even: high capacity utilization will reach break-even faster thus earning profit earlier 

• Low marginal costs: If the extra cost of providing a particular product to an additional customer is close to zero, then high capacity utilization is important for profitability

DIS of high capacity utilization rate (4)

• Minimal time for maintenance repairs 

• Stress on workforce which can result in problems with quality

• Negative impact on service including long waiting times or health and safety dangers, overcrowding 

• Not a substitute for growth as growth is limited by the maximum capacity