The term 'capacity' means a "constraint" or an upper limit. Determining the right level of capacity is one of the most challenging tasks facing managers. Having too much capacity relative to demand means incurring sizable costs to an unused capacity. Having too low capacity means that the demand from some customers may be unfilled. These customers may go to other sources of supply and never return. Therefore, it is equally important to understand the concepts and impact of an appropriate capacity level.
Theoretical Capacity
Theoretical capacity is the denominator-level concept that is based on producing at full efficiency all the time.
For example, if Everest steel industries can produce 15 units of wardrobe per shift when the production lines are operating at maximum sped and if a shift consists of 8 working hours giving 3 shifts per 24 hour a day then the annual theoretical capacity is 15 units x 3 shifts x 360 days = 16,200 units.
Practical Capacity
Practical capacity is a denominator-level concept that reduces the theoretical capacity by unavoidable operating interruptions such as scheduled maintenance time, shutdowns for holidays and so on. Assume that the practical production rate is 12 units per shift and the industry can run 300 days a year, then the practical annual capacity is 12 units x 3 shifts x 300 days = 10,800 units.
Normal Capacity
Both theoretical and practical capacity measure what a plant can supply. In contrast, normal capacity measures the denominator level in terms of demand for the output of the plant. Normal capacity utilization is a concept based on the level of capacity utilization that specifies the average customer demand over a time period, that includes seasonal, cyclical and trend factors.
Budget Capacity
Budget capacity is the denominator-level concept based on the expected level of capacity utilization for the budget period.
