Key or Limiting Factor
Key or limiting factor is the factor, which limits the level of activity or the volume of output of a firm at a particular point of time. The objective of every business is to earn maximum profit. There are a number of factors, which limit the profit earning capacity of an undertaking. The management of the organization has to assess the influence of these factors on the profitability. In normal course of operation, the product mix will be decided upon by contribution. But in case of limiting factor, the contribution must be assessed in terms of contribution per limiting factor. For a company, where the sales cannot exceed beyond a limit the sales will be the key factor. In some cases, there will be sufficient sales and employees, but materials will not be available to produce to cater the full orders. In such cases, material becomes the key factor. The key factor can be defined as the factor in the activities of an undertaking, which at a particular point in time or over a period will limit the volume of output.
If there is a key factor for the undertaking, the profitable position of the undertaking can be reached by computing the maximum contribution per unit of key factor. The profitability can be measured by the following formula:
Profitability = Contribution/Key factor
Some of the examples of key factors are sales, labor, finance, material, plant capacity, etc.
Key Factor - Raw Material
Illustration
The following particulars are extracted from the records of a company:
|
Particulars
|
Per unit
|
|
|
|
Product A
|
ProductB
|
|
Sales
|
Rs.50
|
Rs.60
|
|
Consumption of material
|
1 kg
|
1.5 kg
|
|
Material cost
|
Rs.5
|
Rs.7.5
|
|
Direct wages cost
|
Rs.7.5
|
Rs.5
|
|
Direct expenses
|
Rs.2.5
|
Rs.3
|
|
Machine hours used
|
0.5
|
1
|
|
Overhead expenses:
|
|
|
|
- Fixed
|
Rs.2.5
|
Rs.5
|
|
- Variable
|
Rs.7.5
|
Rs.10
|
Direct wages per hour is Rs.2.5. Comment on the profitability of each product (both use the same raw material) when raw material is in short supply. Assuming raw material as the key factor, the availability of which is 5,000 kgs. and maximum sales potential of each product being 1,750 units, find the product mix which will yield the maximum profit.
Solution
|
|
|
Per Unit
|
|
|
Particulars
|
Product A
(Rs.)
|
Product B
(Rs.)
|
|
I.
|
Sales
|
50
|
60
|
|
|
Material
|
5.00
|
7.50
|
|
|
Direct wages
|
7.50
|
5.00
|
|
|
Direct expenses
|
2.50
|
3.00
|
|
|
Variable overhead
|
7.50
|
10.00
|
|
II.
|
Total marginal cost
|
22.50
|
25.50
|
|
III.
|
Contribution (I - II)
|
27.50
|
34.50
|
|
IV.
|
Material received per unit
|
1 Kg.
|
1.5 Kg.
|
|
V.
|
Contribution per kg. of material
|
27.50
|
23.00
|
When the raw material is limiting factor, product A is more profitable because contribution per kg of raw material of product A is more than that of B.
Availability of raw material is 5,000 kgs and maximum production limit is 1,750 units of product A and 3,500 units of product B. Therefore, the raw material allotment will be as follows:
|
|
|
|
|
Rs.
|
|
Product A
|
= 1,750 units @ 1 kg
|
|
1,750 kgs
|
|
|
Product B
|
= 2,167 units @ 1.5 kg
|
|
3,250 kgs
|
|
|
|
|
|
5,000 kgs
|
|
|
Calculation of Profit
|
|
|
|
|
Product A
|
= 1,750 units @ Rs.27.5
|
|
|
48,125
|
|
Product B
|
= 2,167 units @ Rs.34.5
|
|
|
74,750
|
|
|
|
|
|
1,22,875
|
|
Less:
|
Fixed cost: Product A 1,750 x 2.5
|
|
4,375
|
|
|
|
Product B 2,167 x 5
|
|
10,833
|
15,208
|
|
|
Total profit
|
|
|
1,07,667
|
Thus, product mix of 1,750 units of Product A and 2,167 units of Product B will give the maximum profit of Rs.1,07,667.
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