Capacity Utilisation: What Is It and How To Calculate It

Capacity Utilisation: What Is It and How To Calculate It

Reading time: 6 minutes

Understanding capacity utilisation is essential for economies and industries to determine a production pattern that aligns with their resources and capabilities. In simple words, capacity utilisation is the degree to which a company's resources are employed to produce maximum capacity.

It is a key performance indicator used to assess the effectiveness of industries and production facilities. A higher rate reflects optimal resource utilisation, whereas a lower rate indicates inefficiencies, untapped growth potential, or under-utilised assets. By analysing capacity utilisation trends, business owners and investors can assess the performance of their industry, decide whether to expand or scale back production, and efficiently navigate the ever-changing market demands.

In the United States, the Federal Reserve monitors capacity utilisation rates in 89 industries within mining, manufacturing, and utilities. According to economy.com, the capacity utilisation rate in the US was 78.57% in December 2023.

How Do You Calculate the Capacity Utilisation Rate?

It is calculated using a very simple formula:

Capacity utilisation rate = (actual output / potential output) x 100

Actual Output: Refers to the number of units produced by a business or economy over a given time period.

Potential Output: The productivity level attained by the business or economy when all available resources are utilised without increasing operating costs.

For example, let’s say a car manufacturing company has the capacity to produce 100 cars each day, each costing $15,500. Due to certain limitations, the company can now produce only 80 cars daily.

Let's calculate the potential output when the factory runs at total capacity:

Potential output = total capacity x cost per car

Potential output = 100 x $15,500 = $1,550,000

Next, let's calculate the actual output under current capacity:

Actual output = current capacity x cost per car

Actual output = 80 x $15,500 = $1,240,000

Now, let's calculate the capacity utilisation rate:

Capacity utilisation rate = (actual output /potential output) x 100

= ($1,240,000 / $1,550,000) x 100 = 80%

The calculations show that the capacity utilisation rate of the car manufacturing company is 80%.

What is the optimal capacity rate? It is the ideal balance between too much and too little production. For most economies and industries, a capacity utilisation rate of 85% to 100% is ideal.

What Is Its Economic Significance?

As market demand rises, so does the capacity utilisation rate, acting as an inflation indicator for economists. Economists often use this method to decide how effectively industries use manufacturing resources. Low utilisation rates reflect resources not being used to their fullest potential. This can lead to decreased demand and surplus commodities and, eventually, a fall in prices. On the other hand, excessive demand can lead to inflation due to increased utilisation and result in the rise of prices.

The capacity utilisation of an economy shows economic growth. A high rate suggests that the economy is doing well and the GDP is increasing. Economies with high capacity utilisation attract investors who see businesses with excellent efficiency as the ones to invest in. As capacity utilisation increases, businesses may need to increase their workforce to meet rising production demands. This results in increased employment opportunities and encourages consumer spending, thus contributing to economic growth.

How Can Industries Improve Their Capacity Utilisation?

Low capacity utilisation is a common concern industries face across the world that affects their production and efficiency level, and ultimately results in lower profits. It can be due to a lack of skilled employees and inefficient operational methods. Sometimes, it could simply mean that the employees feel demotivated and need a boost. However, proactive actions can be implemented to solve this concern. 

Industries can provide value to themselves and their investors by simplifying processes to decrease non-billable tasks and selectively outsourcing orders. Furthermore, acquiring new clients and diversifying assignments are essential tactics for ensuring a consistent supply of billable work, which improves utilisation rates. Finally, achieving optimal capacity utilisation requires industry leaders to engage in informed strategic planning, effective resource allocation, and capitalising on new opportunities to generate long-term success.

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Source - database | Page ID - 38171

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