Capacity quality and inventory - Capacity planning and utili...

Learning Outcomes

After reading this article, you will be able to define capacity and explain the different types of capacity relevant to business operations. You will understand how organisations plan, measure, and utilise capacity, recognise causes and effects of over- or underutilisation, and identify strategies to match capacity with demand. You should be able to apply these concepts to improve operational efficiency and inventory management in various contexts.

ACCA Business and Technology (BT) Syllabus

For ACCA Business and Technology (BT), you are required to understand the principles behind capacity planning and utilisation, and how they affect organisational performance. Key areas for revision in this article include:

• The meaning and types of capacity (theoretical, actual, effective)
• Capacity planning approaches in operations management
• Measurement of capacity utilisation
• Impact of over- and underutilisation of capacity
• Techniques to manage capacity and align it with demand
• The connection between capacity management, quality, and inventory levels

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Define capacity utilisation and state one reason why it is important for a manufacturing business.
2. What problems might arise from sustained underutilisation of capacity?
3. Give two methods an organisation could use to increase its effective capacity during periods of high demand.
4. Differentiate between theoretical and effective capacity with a practical example.

Introduction

Capacity planning ensures an organisation has enough resources—machinery, people, facilities—to meet expected demand efficiently. Balancing capacity and demand directly affects costs, quality, inventory, and customer satisfaction. Effective capacity management helps organisations avoid unnecessary investment in unused resources while minimising lost sales from shortages.

Key Term: Capacity
The maximum output or workload that an organisation, machine, or system can achieve in a specific period under given conditions.

Key Term: Capacity Utilisation
The proportion of maximum output actually achieved over a set period, typically expressed as a percentage.

Types of Capacity

Organisations must distinguish between different measures of capacity, as using only one figure may be misleading. The main types include:

• Theoretical (Design) Capacity: The maximum possible output without any downtime.
• Effective Capacity: The output possible under normal working conditions, factoring in planned maintenance, breaks, and expected interruptions.
• Actual Capacity: The output achieved in practice, which may be lower than both the theoretical and effective figures due to unplanned problems.

Worked Example 1.1

A production line is rated to produce 10,000 units per week but usually only achieves 8,000 units. Last week it produced 7,200 units. What are its capacity figures this week?

Answer:
Theoretical capacity: 10,000 units
Effective capacity: 8,000 units
Actual output: 7,200 units
Capacity utilisation (actual vs effective): (7,200 ÷ 8,000) × 100% = 90%
Capacity utilisation (actual vs theoretical): (7,200 ÷ 10,000) × 100% = 72%

Planning Capacity

Capacity planning is the process of determining how much production capability is needed to meet forecast demand. It is a core part of operations management and affects staffing, equipment purchase, facility size, and inventory levels.

Key Term: Capacity Planning
The process of forecasting and deciding the required production capability to meet demand over a specific period.

Measuring Capacity Utilisation

Capacity utilisation is a key performance indicator for operational efficiency. It can be calculated as:

$\text{Capacity Utilisation (\%)} = \frac{\text{Actual Output}}{\text{Maximum or Effective Capacity}} \times 100$

High utilisation often indicates resources are being used efficiently, but extremely high levels may lead to quality issues or machinery breakdown.

Worked Example 1.2

ABC Ltd has two machines both rated at 40 units per day. Machine A produces 40 units every day; Machine B produces 30. What is their respective capacity utilisation?

Answer:
Machine A: (40 ÷ 40) × 100% = 100%
Machine B: (30 ÷ 40) × 100% = 75%

Underutilisation and Overutilisation

Underutilisation means unused resources, higher per unit costs, and possibly demotivated staff. Inventory levels may rise if too much is produced.

Overutilisation occurs when capacity is stretched to its limits. This can cause quality problems, increased maintenance, stress on employees, and lost sales if orders can't be fulfilled.

Worked Example 1.3

A bakery operates at 130% capacity during the Christmas rush by taking on overtime and temporary staff. What risks might result from this strategy?

Answer:
Potential risks include errors leading to lower product quality, equipment failures, increased staff fatigue, and possible customer dissatisfaction if late orders occur.

Managing Capacity and Demand

Businesses use several techniques to respond to fluctuating demand:

• Adjusting workforce size (e.g., overtime, temporary staff)
• Outsourcing parts of production
• Scheduling maintenance during quieter periods
• Shifting demand through pricing or promotions
• Expanding or reducing facilities in the long term

Key Term: Bottleneck
A point in the process where capacity is less than demand, limiting the overall output of the system.

Quality, Capacity, and Inventory

High capacity utilisation may affect quality if workers hurry or skip controls to keep up with demand. Conversely, running below capacity can lead to excess inventory, which increases storage costs and the risk of waste or obsolescence.

Key Term: Inventory
The materials and goods an organisation holds for production or sale.

Exam Warning

Operating at or above 100% effective capacity increases risk of errors, breakdowns, and falling quality. Remember that capacity should be aligned with maintaining standards, not just maximising output.

Matching Capacity and Demand

Continuous monitoring of demand forecasts and actual sales is essential. When demand regularly outpaces capacity, management should consider investing in more resources; when demand falls, downsizing or repurposing capacity may be necessary.

Revision Tip
Always distinguish between maximum (theoretical) and effective capacity in calculations. For most exam questions, unless specified, use effective capacity as the base for utilisation.

Summary

Effective capacity planning ensures an organisation uses its resources productively, maintains suitable inventory levels, and delivers consistent quality. Over- or underutilisation can both increase costs and damage performance. Regular review and adjustment of capacity help prevent waste and maintain customer satisfaction.

Key Point Checklist

This article has covered the following key knowledge points:

• Define capacity, effective capacity, and capacity utilisation, and explain their relevance.
• Calculate and interpret measures of capacity utilisation.
• Recognise risks and costs associated with both underutilisation and overutilisation.
• Identify methods to match organisational capacity with fluctuating demand.
• Assess the impact of capacity choices on quality control and inventory management.

Key Terms and Concepts

• Capacity
• Capacity Utilisation
• Capacity Planning
• Bottleneck
• Inventory