Resources required for production can be quite scarce. Besides, one level of input might be needed to produce different products at different levels of output.
Limiting factor analysis is the technique used to figure out how to maximize your production output despite the various limitations that confront the production process. Every business aims to maximize profit; therefore, it is essential to analyze the best combination of limiting factors to yield maximum return.
It might prove somewhat tasking to make the most out of the resources available. As such, you’ll need a proper understanding of how best to analyze the limiting factors within your organization’s operations.
What is the Limiting Factor Analysis in Management Accounting?
In Management Accounting, Limiting Factor Analysis is a technique that seeks to maximize profit by the appropriate handling of limiting factors.
Before we talk about the analysis itself, let us understand what limiting factors are. Limiting factors are required scarce resources that can restrain an organization from making maximum profits by affecting production outputs.
They are the inputs that determine the limits in the quantity and quality of the products. Such factors may include a shortage of materials, machine capacity, labor, financial capital, etc.
The aim of the analysis is simple – to maximize profit in the end. As such, it entails careful consideration of the limiting factors and their effects on each unit of production.
When you conduct the analysis, you get a clearer picture of each product’s contribution per unit resource used. This will enable you to place greater priority on products with a higher contribution per unit.
You can guess what the result is- more profit and the utilization of scarce resources more effectively.
Since limiting factor analysis is conducted short-term, variable costs, rather than fixed costs, are the only relevant costs to the decision-making process.
Can There Be More Than One Limiting Factor at a Time?
Yes, your business can encounter more than one limiting factor for a given production. For instance, there might be a shortage of labor as well as limited machine power.
Also, one limiting factor can eventually lead to another. For example, insufficient production capital may lead to the inability to purchase enough raw materials. This may, in turn, lead to producing a product below the standard demands in quantity.
Note that you can use Limiting Factor Analysis when there is one limiting factor. In the case of multiple factors, linear programming is employed for a solution to the problem.
How Do You Find a Limiting Factor?
When there is more than one product utilizing a resource, you need a good production plan to stay on course for profit.
For such an effective production plan, you can follow these simple steps.
- Point out the limiting factor
- Find out the units of the resource required for each product.
- Find the per-unit contribution of each product (relative to the resource in question). You can calculate this by subtracting the variable costs from sales.
- Rank the products in decreasing order of contribution per unit of the vital resource.
- Use the ranking as your guide for the allocation of the said resource.
Advantages of Limiting Factor Analysis
Some advantages of limiting factor analysis are as follows;
- A proper analysis of limiting factors will give you an insight into the implications of those factors in your business production.
- It arms you with the right details on how each product utilizes the allocated scarce resources.
- Without this crucial knowledge, you risk channeling your energy and efforts to less essential products.
Disadvantages of Limiting Factor Analysis
Simple limiting factor analysis is often useful only when there is just one limiting factor affecting the production.
When there are multiple constraints, it will take some much more complex methods to deduce meaningful conclusions to aid decision-making. This is because there are more details to capture in the analysis if it must be useful.
It simply implies that you will have to go through more rigor. In the long run, you might need to employ the services of an advanced professional. Of course, this interprets as an extra cost.
Given the scarce nature of the most relevant resources, you must make every effort to allocate these resources efficiently. To do this, you need to know which combination of products gives you the most investment return.
With suitable limiting factor analysis, you can be sure you will set your priorities right and maximize business profits.