5 Limiting Factor Analysis

Question 1

limiting factor

Answer 1

factor in scarce supply that limits the organisation from expanding activity (demand, production factor - labour, material etc)

• to check whether limiting factor other than demand is present, budgeted demand x needed resource needs to be compared vs available resource,
• when limiting factor is present, to maximize profit products need to be ranked in order of product contribution per unit of scarce resource (marginal costing applies),
• and then production planned according to the rank and max demand for products within limits of supply,
• if two factors are potentially limiting, check if any of them really is limiting. If none = no limits, if one = rank like above, if two = linear programming

Question 2

limiting factor analysis assumptions

Answer 2

fixed costs the same regardless of decision made —> contribution-maximizing output = profit maximizing output;
unit variable cost constant regardless of quantity;
sales demand and resources requirements per product are certain;
units of output are divisible (or rounding necessary)

Question 3

Restrictions on freedom of action

Answer 3

sometimes, production planning according to ranking of cont/limiting factor unit cannot be applied fully due to other constraints such as preexisting contracts, need to maintain market share, complementary products etc. In such situations, there needs to be additional step after ranking products but before planning production: taking into account minimal production requirements for each product.

Question 4

Make or buy

Answer 4

calculate saving (= price if bought from outside minus produced internally) per unit of limiting factor, rank products from biggest saving, produce those with biggest saving, buy the rest. —> Total costs minimised when extra variable cost per unit of scarce resource is lowest.

Question 5

Shadow price (dual price, internal opportunity cost)

Answer 5

marginal contribution per unit of limiting factor (scarce resource) that would be added if extra resource were available AT original variable cost; also: maximum extra that organisation would be willing to pay to get that resource from outside (if one unit of resource was taken away, contribution towards fixed costs would drop by this much, so it’s worth buying to make extra contribution).

Question 6

Pertinent non-quantifiable issues

Answer 6

other issues that cannot be put into numbers that impact production and sales decisions, ie. impact on demand, customer goodwill, brand awareness, locking out competitiors, loss of skilled labour etc.