Question

If there is a scarce resource that is restricting sales, how will the business maximise its profit? Explain the logic of the approach that you have identified for maximising profit.

Answer 1

Scarce resource utilisation also called limiting factors decision, is judgment of the best use of scarce resources available to an enterprise so as to maximise the total profits. Scarcity of different resources puts constraints on the amount of production.

For example, a business may have limited number of machine hours, thus limiting the production to the available man hours only.

The allocation of a scarce resource must be based on the contribution margin per unit of the scarce resource from each product. A simple scarce resource allocation decision involves the following steps:

1. Calculate the contribution margin per unit of the scarce resource from each product.
2. Rank in decreasing order of contribution margin per unit of scarce resource.
3. Calculate the number of units of each product that can be produced within the given scarce resource.
4. Allocate scarce resource first to the product with highest contribution margin per unit of scarce resource, then to the product with next highest contribution margin per unit of scarce resource and so on

EXAMPLE:

Consider this table.

Product	A	B
Sale Price	500	300
Material Cost	150	80
Labour Cost	100	50
Variable Overhead	40	30
Fixed Overhead	20	20
Admin Expenses	10	10
Total Cost	320	190
Net Income	180	110
Machine Hours needed	2	1.5
RAKING as per CONTRIBUTION PER MACHINE HOUR
Sales price	500	300
Total variable cost	300	170
Contribution	200	130
Machine Hours needed	2	1.5
Contribution per machine hour	100	86.67
RANK	FIRST	SECOND

Now, let the available machine hours 2000 hours. Production of A be 700 units and Production of B be 500 units

As the above Contribution per hour of A is more than B, thus the available hours should first be allocated to the use of producing A and then B.  

A = 2 hours * 700units = 1400 hours

B = 1.5 hours* ___ = 600 hours

(As total hours are 2000 hours we used 1400 for A we left with 600 hours for B)

Thus we can only make 600/1.5 = 400 units of B because of limiting factor machine hours to MAXIMISE PROFITS.