What is 'Capacity'

Capacity is the maximum level of output that a company can sustain to make a product or provide a service. Planning for capacity requires management to accept limitations on the production process. No system can operate at full capacity for a prolonged period; inefficiencies and delays make it impossible to reach a theoretical level of output over the long run.

!--break--Every component of production operates within a relevant range. No piece of machinery or equipment can operate above the relevant range for very long. Assume, for example, ABC Manufacturing makes jeans, and that a commercial sewing machine can operate effectively when used between 1,500 and 2,000 hours a month. If the firm has spikes in production, the machine can operate at more than 2,000 hours for a month, but the risk of a breakdown increases. Management has to plan production so that the machine can operate within a relevant range.

Differences Between Capacity Levels

Theoretical capacity assumes a constant level of maximum output. This production level assumes no machine or equipment breakdowns and no stoppages due to employee vacations or absences. Since this level of capacity is not possible, companies should instead use practical capacity, which accounts for repair and maintenance on machines and employee scheduling.

How the Flow of Manufacturing Cost Works

Managers plan for production capacity by understanding the flow of costs through the manufacturing process. ABC, for example, purchases denim material and ships the material to the factory floor. Workers load the material into machines that cut and dye the denim. Another groups of workers sew parts of the jeans by hand, and then the jeans are packaged and sent to a warehouse as inventory.

Factoring in Bottlenecks

A manager can maintain a high level of capacity by avoiding bottlenecks in the production process. A bottleneck is a point of congestion that slows the process, such as a delay in getting denim materials to the factory floor or producing flawed pairs of jeans due to poor employee training. Any event that stops production increases costs and may delay a shipment of goods to a customer. Delays may mean the loss of a customer order and possibly the loss of future business from the client. Management can avoid bottlenecks by working with reliable vendors and properly training employees. Every business should budget for sales and production levels and then review actual results to determine whether production is operating efficiently.

BREAKING DOWN 'Capacity'

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