Capacity Management

• Capacity is the potential or capability,  of a set of resources to do work of some type to create value for the customer.
• Levels of capacity for organization consideration

* Theoretical -  Maximum possible (not practical)

*  Practical -  Downward adjustment of theoretical to
make allowance for unavoidable capacity losses

*  Normal - Average output over past 3-5 years

*  Budgeted - Expected in upcoming year

*  Actual - Work actually done during current year

•  Goal of capacity management is to manage fixed costs (plant assets)   in a manner that spreads costs over the largest possible volume
• A very difficult area of management because it involves long-range planning

A Capacity Manaagement Example

Company A and Company B each manufacture one product that is very similar in nature.  Company A recently invested in modern machinery (new technology) that reduces its manufacturing labor cost.  Company B continues to be labor intensive using its older machinery.  Accordingly, Company A has much more fixed factory overhead annually than Company B (\$ 1,500,000 compared to \$ 600,000).  The respective selling price and variable costs per unit are as follows:
Company A              Company B

Selling Price                         \$ 20.00                         \$  20.00

Direct Materials                  \$  2.00                           \$    2.00
Direct Labor                         \$  1.00                           \$   6.00
Variable Overhead               \$  1.00                          \$    1.00

Required:    Compute the gross margins on the product of each company assuming an annual volume of production and sales of 100,000 units;  then 200,000 units.

Solution:             (100,000 units)
Cost:
Variable Costs/Unit     \$  4.00                       \$  9.00
Fixed Cost/Unit             15.00                           6.00
Total Cost/Unit            \$19.00                       \$ 15.00

Selling Price                       \$20.00                       \$ 20.00

Total Gross Margin            \$100,000                 \$ 500,000

(200,000 units)
Only change is Fixed
costs per unit             \$ 7.50                          \$ 3.00

Total Gross Margin             \$ 1,700,000             \$ 1,600,000