Every business has a specific potential production capacity at a given moment in time. For instance, your company's production line could potentially make 10,000 bottles of sauce a week or your mechanics could perform 10,000 car services over a month. The proportion of this capacity being used in a period of time is known as capacity utilisation, and it can be calculated using the capacity utilisation formula.
This formula can help business owners better understand the way their company operates and predict problems such as surging demand that will require more capacity, or a slowdown that means your business has excess unused capacity.
Understanding capacity utilisation
Capacity utilisation is a valuable metric for business owners to gauge whether they are operating within, below or beyond their full capacity.
“Simply put, measuring capacity utilisation is how we match the potential of a business to its actual output," says Nik Nicholas, managing partner at consulting group Covalent. "Think of it like a car engine – if it’s running below potential then you aren’t getting the full benefit or value from the engine’s capabilities."
What does the capacity utilisation rate mean for my business?
Tracking the capacity utilisation of your company over time can be helpful in understanding potential problems before they occur. A rapid rise in your capacity utilisation, for example, might suggest you need to invest in higher capacity to deal with demand. Meanwhile, a decrease in utilisation might mean you’re spending more than you need to.
“Capacity utilisation is essential for strategic planning and lean operations,” adds Nicholas. “By aligning resources with demand and eliminating waste, organisations can significantly improve their overall efficiency.”
At Scottish-based alcoholic drinks company Highland Boundary, the business has a true production output of around 7,000 bottles of spirits per year. However, their potential capacity is actually about 20% higher than this, explains founder Dr Marian Bruce.
Maintaining this amount of capacity utilisation allows the company to be confident it can meet orders in a market where the supply of raw materials can be challenging.
"We hand-pick botanicals for our spirits and liqueurs, in ways that restore biodiversity," explains Bruce. "In turn, that means supply can be variable at different times of the year, and we can’t simply make more bottles of something if we don’t have the ingredients. Our supply chains now mean we can wait months for something that used to take days."
Stopping short of maximum capacity also helps Highland Boundary to manage land and storage costs. “By working to something very near to a just-in-time supply chain, we can minimise the amount of product we need to store, which helps with our cash flow. If we increased production, we would also need to increase the land we have for picking ingredients, which would also increase costs,” Bruce adds.
Managing your business' cash flow alongside vendor and supplier payments can be a tough balancing act, especially when the end of the month draws near and bills are due. With an American Express® Business Gold Card, you get up to 54 days to clear your Card balance, so you can keep your money in the account for longer and get more flexibility in your cash flow¹.
What’s a 'good' capacity utilisation?
In a perfect world, businesses would consistently operate at 100% capacity utilisation to maximise their profit margins. However, this isn’t always viable or realistic. Supply chain disruption, demand fluctuations, seasonal variations, technological faults or manufacturing challenges can all hinder a business’ ability to operate at 100% capacity.
Like Highland Boundary, if your business has a capacity utilisation of roughly 80%, you strike a fair balance between efficiency and adaptability. This amount allows you to maintain high levels of output and production while retaining leeway to accommodate surges in demand. Moreover, operating slightly below your full capacity also provides business owners with the opportunity to fine-tune operational processes, improve quality and trim lead times.
However, there is no one-size-fits-all solution when it comes to capacity utilisation. Many businesses deal with fluctuations in their capacity output all year round, and for some this is unavoidable. Try to identify a ‘safe zone’ where your output and margins remain high, but your operations and workforce aren’t stretched too thin.
Capacity utilisation formula
Capacity utilisation is expressed as a percentage of potential capacity used and is calculated using the following formula:
(True Output / Potential Output) x 100 = Capacity Utilisation Rate
Capacity utilisation example
Company A is a food manufacturing business that makes soups at its factory. The factory production line is capable of turning out 100,000 cans of soup each week. Last week, Company A made 75,000 cans of soup. Using the formula for capacity utilisation we can see this business has a utilisation rate as shown below:
(True Output = 75,000 / Potential Output = 100,000) x 100 = 75%
(75,000 / 100,000) x 100 = 75%
The company is operating below its capacity potential. It has a spare capacity of 25%.
How do I increase my capacity utilisation?
It’s important to consider what factors limit your capacity utilisation before trying to increase it. Adding more people to your workforce might not necessarily lead to higher capacity utilisation if the issue is that your production line can’t expand, or you don’t have access to enough raw materials.
A business might be operating below capacity for a number of reasons, including fluctuating market conditions, or a loss of market share. Some businesses will see lower capacity utilisation immediately after hiring new staff - as it may take time to train them - or investing in increased capacity, such as buying a new production line that needs to be integrated into the business.
Making an investment in increased capacity in the right way offers more potential to drive revenue and profits – but it does rely on having funds available. If your business is operating close to or beyond its maximum capacity, you might use Membership Rewards® points in the short term to motivate your employees with a team lunch or reward them with a Gift Card, or redeem your points as a statement credit to reinvest in new equipment².
The way in which a business specifically increases its capacity utilisation will vary according to the industry and the nature of the business. Factors at play may include:
- Equipment: Could your business invest in new production lines?
- Facilities: Could you increase the size of your buildings or add new technology?
- Labour: Would adding more people to the workforce allow for higher capacity?
Capacity utilisation is best viewed as a rough indicator of your business performance, says Bruce: “Around 80% utilisation is a reasonable figure to work to, but it’s important to remember there are so many other constraints that you might have different figures for different parts of production,” she says.
“Capacity utilisation can be a simple way to look at what’s actually a complex set of underlying metrics.”
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.
2. Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
