ShmoopTube

Where Monty Python meets your 10th grade teacher.

Search Thousands of Shmoop Videos


Cost Accounting Videos 27 videos

Cost Accounting: What is a Cost: Cost Versus Expense?
1 Views

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...

Cost Accounting: How Can Unit Fixed Costs Mislead the Misled?
3 Views

How can unit fixed costs mislead the misled? Unit fixed costs can be misleading because the fixed cost per unit decreases as production increases;...

Cost Accounting: What Is Differential Analysis?
2 Views

What is Differential Analysis? Differential analysis is a strategy used to make the best decision. Possible choices are compared to determine which...

See All

Cost Accounting: How Do Capacity Constraints Work on The Bottom Line? 0 Views


Share It!


Language:
English Language

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

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
39794 Views

GED Social Studies 1.1 Civics and Government

Fake News
11938 Views

How do you tell fake news from real news?

Finance: What is Bankruptcy?
260 Views

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...

Finance: What is a Dividend?
1777 Views

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...

Finance: How Are Risks and Rewards Related?
589 Views

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...