ShmoopTube
Where Monty Python meets your 10th grade teacher.
Search Thousands of Shmoop Videos
Cost Accounting Videos 27 videos
What is a Cost: Cost Versus Expense? Cost and expense are pretty similar terms when looking at traditional definitions but they’re a little diffe...
How can unit fixed costs mislead the misled? Unit fixed costs can be misleading because the fixed cost per unit decreases as production increases;...
What is Differential Analysis? Differential analysis is a strategy used to make the best decision. Possible choices are compared to determine which...
Cost Accounting: How Do Capacity Constraints Work on The Bottom Line? 0 Views
Share It!
Transcript
- 00:00
and finance Allah shmoop How do capacity constraints work on
- 00:05
the bottom line All right people you're the CEO of
- 00:09
Little Poker is a company that makes shrimp forks You
- 00:12
just received an order for twenty thousand forks from a
- 00:15
shrimp fest in Gulf Port Mississippi Big order Big revenue
Full Transcript
- 00:18
It should be time to pop the champagne and celebrate
- 00:21
but there's a problem You currently make forty eight thousand
- 00:24
forks per month and you only have capacity for fifty
- 00:27
thousand a month Which means that your facility working at
- 00:30
full speed has a limit or a constraint of fifty
- 00:33
thousand units that it can produce in any given month
- 00:36
Well we've run into a problem known as capacity constraints
- 00:39
You just don't have enough capacity now to fulfill the
- 00:42
Gulf port order in a timely fashion They want delivery
- 00:45
in two months and it would take you ten months
- 00:47
to make it the additional twenty thousand You need to
- 00:50
fill the order right So why not just increased capacity
- 00:53
Well it might not be that easy Whether you can
- 00:55
take the order or not depends on the specific reason
- 00:58
you have a cap on your production Well there are
- 01:00
different kinds of capacity constraints In your case Well you
- 01:03
don't have enough machines to make more than fifty thousand
- 01:06
a month If you want to expand production you'LL have
- 01:08
to buy some additional equipment It's very expensive solution to
- 01:11
the problem here Well they already be worth that additional
- 01:14
costs Buying those machines In other words is your bottom
- 01:17
line hurt or helped by an attempt to break through
- 01:20
your capacity constraint Well before we tackle that question directly
- 01:23
let's look at some other potential reasons that company's capacity
- 01:26
might be constrained Some situations are easier to fix than
- 01:29
others For instance the company might not have enough workers
- 01:32
will If that's the case they could just hire extra
- 01:34
people pay him a little bit of overtime to increase
- 01:36
production or they can pay a lot of overtime to
- 01:39
their current workers The only thing to look out for
- 01:41
with additional labor is whether the increased costs are going
- 01:44
to cut into their profit margins Bringing in additional workers
- 01:48
shouldn't matter The gross profit and gross margin figures already
- 01:52
include the cost of direct labor The new workers will
- 01:54
make more products The additional cost come with additional revenue
- 01:58
gross margins stay the same But using overtime workers that
- 02:02
you have to pay a lot of overtime to could
- 02:03
get too costly to be worth it Well since the
- 02:06
company would pay more per hour in the overtime shift
- 02:08
the gross margins for the products made during that time
- 02:11
would decrease On the other hand getting more use out
- 02:14
of the machinery and overhead means that the company is
- 02:16
able to leverage its operating expenses Mohr And that's a
- 02:18
good thing The overtime costs might hurt gross margins but
- 02:21
operating margins might not be impacted as much they might
- 02:25
even improved while based on the situation Right lot of
- 02:28
moving parts here another potential capacity constraints Not enough raw
- 02:32
materials like say you make caviar ice cream and your
- 02:35
supplier can't provide enough caviar to make more than ten
- 02:38
thousand gallons of ice cream a month That raw material
- 02:41
constraint limits your production will The solution here involves finding
- 02:44
an additional source of product or caviar The main worry
- 02:47
though in terms of the bottom line would be well
- 02:50
what if the prices for that extra caviar are really
- 02:53
high Getting additional raw materials might force you to tap
- 02:56
into a way more expensive means of obtaining them like
- 02:58
to get more caviar You might have to await into
- 03:00
expensive Russian black markets Make more than ten thousand gallons
- 03:04
of the caviar ice cream in the class per gallon
- 03:07
might actually increase We'LL all that expensive black market caviar
- 03:10
then you know really cuts into your profits Is it
- 03:12
worth it Is it worth it That's what you're asking
- 03:14
all the time here Or the mere fact that you
- 03:16
need more raw materials could drive prices higher like you're
- 03:19
now a big buyer a big commander of a limited
- 03:22
supply product More demand for the caviar consent Caviar prices
- 03:25
higher across the board Well if your raw materials cost
- 03:28
more it'LL cut into your gross margin of fact That
- 03:30
could make the additional production less profitable and that might
- 03:33
not be worth the effort Remember that's what we're asking
- 03:35
here Is it worth it Is it worth it Okay
- 03:37
back to little pokers In your case that capacity constraint
- 03:40
comes from limits to the output of your machinery You
- 03:43
have two time slapping machines These things here each one
- 03:47
can bust out twenty five thousand marks a month There's
- 03:49
nothing you can do to get them to produce Maur
- 03:52
If you want to increase capacity your only choice is
- 03:54
to buy additional machine Well the first question you have
- 03:57
to ask Can we fit anymore machines in the warehouse
- 04:00
singing here Well if the answer is no and you're
- 04:02
probably s out of luck if you're out of physical
- 04:05
space you may need then a new factory in warehouse
- 04:08
and laborers and all that That's an extremely expensive proposition
- 04:12
Buying a new factory would only make sense if you
- 04:14
force a long term demand well above your current capacity
- 04:17
If you believe that you could make and sell double
- 04:19
your current output for example well then maybe it be
- 04:22
worth it Well luckily for you you don't have to
- 04:24
make that choice Your chief engineer says she can move
- 04:27
things around toe add an additional machine She says she
- 04:30
can do it in such a way that you don't
- 04:31
have to interrupt current production to install the new machine
- 04:34
Right Well the big worries here one Will you have
- 04:36
enough sustained demand justify buying a new machine into How
- 04:40
will the cost of the new machine impact your real
- 04:43
bottom line Well the reason you're considering buying a new
- 04:45
machine because he received a special order from the Gulf
- 04:47
Port Shrimp fest Another time sliding machine cost two million
- 04:50
dollars If you spend that amount just to fill the
- 04:53
one order well then it's a money losing proposition and
- 04:56
or fit Say you buy the machine for two million
- 04:58
dollars and use it to make the additional twenty thousand
- 05:01
additional units It brings in ninety grand in revenue But
- 05:04
then the machine sits idle while you go back to
- 05:06
your normal production levels You lost more than one point
- 05:09
nine million dollars on that deal for buying that machine
- 05:11
that now holds coats very nicely Better to just turn
- 05:14
down that special order not worth it But if that
- 05:17
special order is a sign of long term demand for
- 05:19
Shrimp Fork thing is well it might be worth the
- 05:21
expansion You have your salespeople call around you bring in
- 05:24
some outside consultants who produced a lot of fancy pretty
- 05:26
looking charts you don't really understand but they tell you
- 05:29
bottom line they think there's enough demand to expand capacity
- 05:32
long term So you take the plunge you spend two
- 05:35
million dollars to buy the new machine And yes you
- 05:37
could have leased it for a month or two or
- 05:39
something like that and much higher prices But we won't
- 05:42
get you all complicated here That machine is enough to
- 05:44
increase your capacity to seventy five thousand Shrimp fork Thing
- 05:47
is a month You easily get the special order in
- 05:50
on time The customers so impressed they tell all the
- 05:53
other regional shrimp fest about your company You start to
- 05:56
get tons of orders Literally Infact you become the official
- 05:59
shrimp fork provider for the entire Gulf Coast Enough demand
- 06:02
for seventy five thousand forks a month Additional revenue of
- 06:05
one hundred twelve thousand five hundred dollars a month to
- 06:08
well you're gross Margins on the forks remain steady at
- 06:10
sixty five percent Meaning you bring in gross profit of
- 06:12
seventy three grand from that new product Well you were
- 06:15
able to sign a long term lease for the time
- 06:17
slapping machine that cost you fifty grand a month Yeah
- 06:20
So instead of buying in fall the capital twenty three
- 06:22
thousand one hundred twenty five dollars in new monthly profit
- 06:25
from the expansion Good for you The visitors to all
- 06:28
the Gulf Region Shrimp fest Get a shrimp eating experience
- 06:31
that's a really great and you add to your bottom 00:06:33.635 --> [endTime] line the only real losers here and the shrimp
Related Videos
GED Social Studies 1.1 Civics and Government
What is bankruptcy? Deadbeats who can't pay their bills declare bankruptcy. Either they borrowed too much money, or the business fell apart. They t...
What's a dividend? At will, the board of directors can pay a dividend on common stock. Usually, that payout is some percentage less than 100 of ear...
How are risk and reward related? Take more risk, expect more reward. A lottery ticket might be worth a billion dollars, but if the odds are one in...