The capacity utilization rate is used to evaluate a company’s operational efficiency as well as to quantify the realised potential output in a broader sense. It’s significant because it demonstrates to the corporation how much capacity they still have.
Formula for Capacity Utilization Rate
Investors and management are continually looking for ways to strengthen their company’s financial position. Operational efficiency must be improved to save money and increase revenue and profit in order to make the organisation financially strong. As a result, as an analyst, manager, or investor, it is critical to examine the company’s operational efficiency.
The capacity utilisation rate is one such metric that examines a company’s operational efficiency. In the manufacturing industry, the capacity utilisation rate is commonly utilised.
The formula for the Capacity Utilization Rate is as follows:
Actual direct labour hours worked ÷ budgeted direct labour hours) × 100%.
The capacity utilisation rate is expressed as a percentage.
The above ratio necessitates the use of two distinct functioning components.
The firm’s real output throughout that time period.
Also, the maximum amount of output a company can produce in a given amount of time.
The capacity utilisation rate is a ratio that is used to determine how quickly maximal capacity or output levels are manufactured or consumed. The capacity utilisation rate is expressed as a percentage and can provide valuable insight into management’s estimate capabilities as well as the organization’s overall indifference to capacity expansion at any given time.
The capacity utilisation rate is also known as the plant’s or company’s operating rate.
The capacity utilisation rate can also be used to determine whether there is an economy of scale or a diseconomy of scale. It also aids in determining the company’s breakeven point and the point at which piece costs per unit will grow. Capacity utilisation is commonly utilised in manufacturing organizations that produce physical goods rather than delivering services since tangible goods are easier to assess.
For example, if we look at a manufacturing firm for a financial year, we should be able to figure out how much it produced during that year, and then we can figure out how much it can make in the future. By comparing these two components, we may get an idea of how much capacity the company used during the fiscal year.