Capacity Utilization Rate Formula

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Capacity Utilization Rate Formula
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Capacity utilization is used to assess a company’s operational efficiency. However, this ratio is also used in a broader perspective – it measures the realized potential output. This is important because it shows the company how much they can still utilize.

Here’s the capacity utilization rate formula –

Example of Capacity Utilization Rate Formula

Let’s take a simple example to illustrate the capacity utilization rate formula.

Funny Stickers Co. can produce 60,000 stickers a month. During the last year of 2017, they could only produce 40,000 stickers due to the absence of labors. Find out the capacity utilization of Funny Stickers Co.

We already know the actual output of Funny Stickers Co. during the last month of 2017, i.e. 40,000 stickers. The potential output is 60,000 stickers.

By using the formula of capacity utilization, we get –

Capacity Utilization = Actual Output / Potential Output * 100
Or, Capacity Utilization = 40,000 / 60,000 * 100 = 66.67%.

From the above, we can also find out the slack of Funny Stickers Co. during the last month of 2017.

It is = (100% – 66.67%) = 33.33% slack.

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Explanation of Capacity Utilization Rate Formula

The ratio talks about two separate components.

The first one is the actual output produced by the company.
And the second is the maximum output a company can produce in a given period.

For example, if we look at a manufacturing company for a month, we would be able to discover how much the company has produced during the month; and then we can check how much the company can actually produce. Comparing these two will give us a hint about how much capacity the company has utilized during the month.

If the capacity utilization of a company is less than 100%, then the company can increase its production.
If we look at it from another point of view, we will also be able to see that this utilization rate talks about how much slack a company is doing in a particular time period.

For example, if we see that the capacity utilization is 56% of a company in a given month, then we would also be able to discover how much the company couldn’t utilize during that particular month. The percentage of capacity that the company couldn’t utilize is called “slack”. In the above example, the slack of the company during the month is = (100% – 56%) = 44%.

Use of Capacity Utilization Formula

To understand the application of capacity utilization, we need to take an example.

Let’s say that a pen manufacturing company has produced 80,000 pens per month at $1 per unit. If in a given month, the pen manufacturing company’s potential output is 170,000 pens at the same cost per unit, then the company is running at 47.06% (80,000 / 170,000 * 100) capacity.

From the above example, it’s clear that capacity utilization talks about operational efficiency. Higher the utilization rate, higher would be the operational efficiency of the company.

Even capacity utilization has a great effect on economic policies. When policymakers make economic policies, they look at capacity utilization to figure out how to stimulate the utilization of capacity in the economy.