 units.
This is summarized in the table below.
The product rank describes the order in which the products should be manufactured based on the contribution per unit of limiting factor calculated in step 2. Notice that the total number of machine hours used is the same as the maximum capacity available (1,600 + 750 = 2,350).
The original sales projection for product A was 1,000 units, the limiting factor analysis has shown that the business is only capable of producing 800 units and therefore the sales projection will need to be revised down.
Limiting Factors and Fixed Cost
In all of the above calculations, no account was taken of fixed costs. In the short term, by their nature, fixed costs do not change and therefore cannot impact on the decisions regarding limiting factors and scarce resources. For example, if a fixed rent is paid on a manufacturing unit, the same amount will be paid irrespective of how many units or what type of units are produced. Obviously, in the long term changes can be made to the manufacturing capacity and therefore the limiting factor analysis would need to be repeated.
Maximizing Profit and Limiting Factors
The aim of the limiting factor analysis is to indicate which products to produce in order to maximize profits. This can be demonstrated by comparing the income statement with the units based on the limiting factor analysis (800 product A and 600 product B) to an income statement based on an alternative set of production figures.
Suppose in the above example the fixed costs for the period were 5,000, then the income statement based on the analysis would be as follows:
Suppose instead of the 600 units of product B shown by the limiting factor analysis, the business had chosen to produce say only 520 units of product B. Using a similar approach, the 520 units of product B would have used 520 x 1.25 = 650 machine hours, leaving 2,350 – 650 = 1,700 hours for producing 1,700/2.00 = 850 units of product A. In these circumstances the income statement would be as follows:
Clearly the profit when the units are based on the limiting factor analysis (1,400) are higher than those at the alternative production levels (1,330). The limiting factor analysis has resulted in profits being maximized.
In this example only two products were considered. A similar approach can be applied to any number of products, by simply calculating the contribution per limiting factor for each product, ranking the products in order, and producing up to the maximum sales projection until the units of limiting factor are fully utilized.