Capacity utilization rate is a KPI used to measure the rate at which potential output levels are being met or used. It is also known as the operating rate. It is calculated by dividing the actual output by the potential output and then multiplying by 100 to get a percentage. The potential output could be the number of units the company can actually produce in a given amount of time, or it could be the number of units at which the cost per unit increases. It is best used by companies that produce physical goods, which can be easily quantified and outputs can be expressed in units.
The capacity utilization rate can be an indicator of how the company is utilizing its resources. If this rate is low or it is decreasing over a period of time and the plant is in full operations, then this indicates the plant could be lacking in efficiencies. The equipment may need to be better maintained or the processes reviewed to determine why the expected capacity levels are not being met. The capacity utilization rate could also be low due to a low demand for the product. With lower demand, fewer units need to be made even though the plant has the potential and ability to produce a greater volume.
Higher utilization rates can indicate the plant is running efficiently by meeting expectations. It could also indicate that the plant is reaching its optimum capacity. The company then needs to determine if demand for the product warrants the added cost to increase production either through upgrading equipment or expanding the business.
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