Capacity Cost

Capacity costs are in essence fixed; it is an expense incurred by a corporation or entity to pay for or improve its ability to perform business activities on a larger scale. Costs of this sort typically experience little to no variation from one month to the next, making it much easier to control certain resources in terms of cost change without directly affecting output. Capacity costs are therefore related to things that allow a business to extend its production above a group point or reach markets beyond their current distribution network.

Addressing the cost of capacity is one of the ways to minimize overhead and allow a company to gain more of a net return on the project without having any real chances of output levels. These costs or expenses are a given in business if the business wishes to develop past its present creation limit and generally will be decreased or stayed away from just by lessening staff or closing down business areas, the two of which can diminish limit or re-appropriating. It is hard for any company to escape expenses such as insurance, rent payments, property taxes, equipment depreciation, etc. These are examples of the cost of power. Only by closing down the company or outsourcing the services can these be stopped or minimized.

Capacity cost for most manufacturing facilities

Capacity refers to the highest production amount a business can achieve in producing a product or in delivering a service. Capacity preparation allows management to accept manufacturing process constraints. Capacity requirements planning (CRP) is the method of discerning the production resources available to an organization and whether it can fulfill its production objectives. A wide range of costs is included within the capacity cost concept. As an example, if a company constructs a producing facility to expand its capacity, the subsequent fixed costs are going to be incurred:

  • Building and equipment depreciation
  • Building and equipment maintenance
  • Insurance on the facility and equipment
  • Property taxes
  • Security for the building
  • Utilities

One feature of a cost of production is that while it might be possible to reduce the cost and therefore improve a business’s profitability, it cannot be removed without having some kind of negative effect on the whole project. Common examples of this nature are things like lease or rent installments, devaluation on hardware or apparatus, property expenses, protection, and fundamental utilities like warming. When a company increases its revenue significantly and has to increase its production to ensure that goods are available to its new customers, the company will need to add additional manufacturing facilities. That would increase the cost of all of the capacity listed.

Capacity costs tend to be largely fixed. This implies that a business must incur them even within the absence of any sales activity. There’s some difference of opinion on whether utilities should be classified as a capacity cost. Capacity costs can also be associated more closely with customer demand. During downturns in the business cycle, it is common for companies to adjust their capacity levels, which may include shuttering facilities. To use capacity demand planning, the exact amount of capacity to sustain can be calculated, which measures the required capacity levels at various sales levels and product mixes.

If a distribution center is experiencing a period of high volume because of increased sales productivity, they could add additional workers or additional shifts to stay up with the high demand. These staffing increases are also cost of operation, as they allow the company to increase its production capacity. Service costs can be effectively reduced by moving the job to third parties. However, the result’s usually a better cost per unit produced, since these third parties will include an overhead charge in their pricing. In addition, the increased variable costs paid by third parties appear to decrease an enterprise’s net profit. When the time of high demand is over, the company will cut back on staff to reduce its costs.

 

Information Sources:

  1. wisegeek.com
  2. accountingtools.com
  3. investopedia.com