ACCA-F5

Performance Management 1
ACCA F5
Limiting Factors
14th and 15
th
July
2011
ACCA-F5
Performance Management 2
Limiting Factors
Chapter 7
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Performance Management
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Performance Management 3
dentify limiting factors in a scarce resource situation & select
an appropriate technique
Determine optimal production plan under a single limiting
factor situation, including within the context of "make-or-
buy decision
Formulate & solve multiple limiting factors problem using:
Graph, &
Simultaneous equations
Explain & calculate shadow prices, & discuss their
implications on decision-making & performance management
Calculate slack & explain their implications on decision-
making & performance management
Limiting Factors
Objectives:
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Companies are aIways Iimited in their
production capacity - products or
services
There is aIways restrictions in the
avaiIabiIity/suppIy of one or more
resources
Decisions are needed to optimise
production pIan
Best option seIected wiII maximise
contribution and profit
Limiting Factors
ntroduction
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Limiting Factors
What are Limiting Factors?
A limiting factor is:
any factor that is in scarce supply, &
that stops the organization from
expanding its activities further,
that it limits the organization's activities
t limit the ability of the organization to
undertake all available alternatives
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Limiting Factors
What are Limiting Factors?
Limiting factor limits the organization's
activities
Examples:
Sales demands
Production constraints
Labours supply
Materials available
Manufacturing capacity
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Limiting Factors
Concept
Contribution
profit is maximised when contribution is maximised
Fixed costs remains fixed
Contribution is maximised by maximising
contribution per unit of limiting factor
Decision: based on contribution earned per unit of
limiting factor by each product
This will ensure that the company uses all its
resources effectively & efficiently
f there is constraints in sales demand (limited sales
demand) profit is maximised by producing the
highest-ranked product to the sales demand limit
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Limiting Factors
Concept
'ariable cost is the only relevant cost
Companies may have more than one
limiting factors.
Management must decide on Appropriate
techniques:
Single limiting factor : Ranking method
Multiple limiting factors: Linear Programming
method
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$ingIe Limiting
Factor
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Limiting Factors
Single Limiting Factor
Example 10 (pg 78):
Company makes and sells 2 products: Beauty &
Cutie
Capacity/day: Beauty: 50; Cutie: 40
Contribution/unit: Beauty: $18; Cutie: $28
Direct labour/unit needed: Beauty: 1hr; Cutie:
2hrs
Limiting factor Direct labour hrs/day 100 hrs
Optimum production target?
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Limiting Factors
Single Limiting Factor
Example 1.0 (pg 78)
f no limiting factor
Beauty Cutie Total
Capacity/day (u) 50 40
D Labour/unit (hr) 1 2
Contribution/unit ($) 18 28
Total contribution ($) 900 1120 2020
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Limiting Factors
Single Limiting Factor
Example 1.0 (pg 78)
Limiting factor: 100 D Labour hrs/day
Beauty Cutie Total
Capacity/day (u) 50 40
D Labour/unit (hr)/TotaI needed 1/50 2/80 130 (avaiIabIe 100)
Contribution/unit ($) 18 28
Contribution/D Labour ($) 18 14
Ranking: 1 2
D Labour aIIocated/ No. of units
50/ 50 50/ 25 100hrs
Total contribution ($) 900 700 1600
TtI contribution If 40 units Cutie &
baIance to Beauty (20 units) ($)
360 1120 1400
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Limiting Factors
Single Limiting Factor
Example 1.0 (pg 78)
Limiting factor: 100 D Labour hrs/day
3 steps solution:
Step 1: confirm limiting factor
Beauty Cutie Total
Capacity/day (u) 50 40
D Labour/unit (hr) 1 2
Total D Labour needed (hr) 50 80 130
Total D Labour hr available 100
Shortfall (hr) 30
Confirm D Labour is the limiting factor
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Limiting Factors
Single Limiting Factor
Example 1.0 (pg 78)
Step 2: calculate contribution per unit limiting
factor ($ per D Labour hr)
Step 3: Ranking
Beauty Cutie Total
Contribution per unit ($) 18 28
D Labour/unit (hr) 1 2
Contribution per unit limiting factor($) 18
(18/1)
14
(28/2)
Ranking (allocate limited resource) 1 2
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Limiting Factors
Single Limiting Factor
Example 1.0 (pg 78)
Step 4: Determine production plan
Ranking
Beauty Cutie Total
D Labour hr allocated by Ranking (hr)
50
(50x1)
50
(balance
of 100-50)
100
Production plan (units) 50
(50/1)
25
(50/2)
Total Contribution based on
production plan ($)
900
(50x18)
700
(25x28)
1600
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uItipIe Limiting
Factors
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Limiting Factors
Multiple Limiting Factors
Example 3.0 (pg 80)
f there is excess D Labour & Machine hours
Silver Gold Total
S Price ($/u) 110 140
D Material ($/u) 35 (5kg/u) 33 (6kg/u)
D Labour ($/u) (@$5/H) 25 (5H/u) 40 (8H/u)
'OH ($/u) (DLH) 19 27
FOH ($/u) (McH) 5 25
Contribution/u ($) 31 40
Ranking 2 1
xcess resources To
produce
less more
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Limiting Factors
Multiple Limiting Factors
Example 4.0 (pg 80)
f single limiting factor: D Labour hours (unlimited Machine hours)
Silver Gold Total
Contribution/u ($) 31 40
D Material ($/u) 35 (5kg/u) 33 (6kg/u)
D Labour ($/u) (@$5/H) 25 (5H/u) 40 (8H/u)
Contribution/D Labour
hours ($)
6.2
(31/5)
5
(40/8)
Ranking 1 2
To produce more less
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Limiting Factors
Multiple Limiting Factors
Example 5.0 (pg 81)
f multiple limiting factors: D Labour hours & Machine hours
Silver Gold Total
Contribution/u ($) 31 40
D Material ($/u) 35 (5kg/u) 33 (6kg/u)
D Labour ($/u) (@$5/H) 25 (5H/u) 40 (8H/u)
Contribution/D Labour hours ($)
.2
(31/5)
5
(40/8)
Ranking 1 2
Contribution/D Labour hours ($)
.2
(31/5)
.7
(40/)
Ranking 2 1
Decision ? ?
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Limiting Factors
Multiple Limiting Factors
Where there are multiple limiting factors
the contribution per limiting factor for different
scarce resources may show conflicting priorities
Use Linear Programming to solve the problem:
to identify the optimal production for profit
maximisation
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Limiting Factors
Multiple Limiting Factors
Linear Programming:
s a mathematical technique used to identify
optimal decision variables
when there is more than one limiting factor
Decision variables
refer to the different activities which are competing for
the allocation of the limiting (scarce) resources
2 ways to solve the problems:
Simultaneous equations method
Graphical method
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Limiting Factors
Multiple Limiting Factors
Simultaneous equations method
Step 1 dentify objective variables
Step 2 Determine objective function
Step 3 Construct constraint equations
Step 4 Substitute variables into the
equations
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Limiting Factors
Single Limiting Factor
Example 1.0 (pg 78)
limiting factor: 100 D Labour hrs
Beauty (X) Cutie (Y) Total
Capacity/day (u) 50 40
D Labour/unit (hr) 1 2
Contribution/unit ($) 18 28
Total contribution ($) 900 1120 2020
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Limiting Factors
Multiple Limiting Factors
Simultaneous equations method
Example 1.0 (pg 78)
Step 1 dentify objective variables
The objective variables refer to the quantity of a
course of action which is required to achieve the
optimal solution
Let X = the number of units of Beauty manufactured
Let Y = the number of units of Cutie manufactured
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Limiting Factors
Multiple Limiting Factors
Simultaneous equations method
Example 1.0 (pg 78)
Step 2 Determine objective function
The objective function refers to the objective which
the company wants to achieve
t refers to the maximisation of profitability OR
minimisation of costs
The function is expressed in algebra symbols
Z = 18X + 28Y
Z = the maximised contribution
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Limiting Factors
Multiple Limiting Factors
Simultaneous equations method
Example 1.0 (pg 78)
Step 3 Construct constraint equations
Express the followings as linear equations:
The multiple limiting factors
The defined decision variables
Beauty production = X; Cutie production =Y
X, Y < 0
X > 50 (Beauty capacity)
Y > 40 (Cutie capacity)
1X + 2Y > 100 (Direct labour hours)
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Limiting Factors
Multiple Limiting Factors
Simultaneous equations method
Example 1.0 (pg 78)
Step 4 Substitute variables into the
equations
Beauty production = X; Cutie production =Y
X = 50 (Beauty capacity)
Y = 40 (Cutie capacity)
1X + 2Y =100 (Direct labour hours)
Z = 18X + 28Y
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Limiting Factors
Multiple Limiting Factors
Simultaneous equations method
Example 1.0 (pg 78)
Step 4 Substitute variables into the
equations
1X + 2Y = 100 Z = 18X + 28Y
X = 50; Y = 25; Z = 900 + 700 = 100
#efer to graph - highest point of iso-contribution Iine (objective
Iine) can touch in feasibIe area
f Y = 40; X = 20; Z = 360 + 1120 = 1480
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Limiting Factors
Multiple Limiting Factors
Graphical method:
Example 1.0 (pg78)
(Step 1)
Show the constraint
objective and
feasible region
on a graph:
Capacity of X
(i) X = 50
50 units
X = 50
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Performance Management 30
Limiting Factors
Multiple Limiting Factors
Graphical method:
Example 1.0(pg78)
(Step 2)
Show the constraint
objective and
feasible region
on a graph:
Capacity of Y
(ii) Y = 40
40 units
50 units
X = 50
Y = 40
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Limiting Factors
Multiple Limiting Factors
Graphical method:
Example 1.0(pg78)
(Step 3)
Show the constraint
objective and
feasible region on
a graph: Direct
Labour Hr
(iii) 1X+2Y = 100
X=0; Y=50
Y=0; X=100
50 units
X = 50
DL: 1X+2Y=100
100 units
B: X=50;Y=25
C: X=20; Y=40
y = 40
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Limiting Factors
Multiple Limiting Factors
Graphical method:
Example 1.0(pg78)
(Step 3)
Show the constraint
objective and
feasible region on
a graph: Direct
Labour Hr
(iii) 1X+2Y = 100
X=0; Y=50
Y=0; X=100
Opt point: B
50 units
28 units
X = 50
DL: 1X+2Y=100
100 units
18 units
so-profit line (iso=equal)
18x+28y=504
B: X=50;Y=25
C: X=20; Y=40
y = 40
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uItipIe Limiting
Factors:
$Iack
&
$urpIus
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$Iack refers to a situation when maximum
avaiIabiIity of a resource is not fuIIy utiIised
At optimum production, IF:
a resource avaiIabIe is fuIIy utiIised
Constraint is "binding"
There is no "sIack"
a resource avaiIabIe is not fuIIy utiIised
Constraint not binding
There is "sIack"
Limiting Factors
Slack
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Limiting Factors
Slack: Example
Products X Y Max
Machine H/u 3 10 330H
D M kg/u 16 4 400kg
D L H/u 6 6 240H
Contribution
$/u
5 7
Max demand any 12
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Limiting Factors
Slack: Example
The constraint equations are:
Product X & Y
X, Y < 0, Y > 12
Mc H : 3X + 10Y > 330
D M: 16X + 4Y > 400
DL: 6X + 6Y > 240
Z = 5X + 7Y (maximise profit)
Substitute into equations and present in graph
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Limiting Factors
Slack: Example
Graphical method:
Show the constraint
objective and
feasible region on
a graph:
X = 12
Mc H: 3X+10Y = 330
DM: 16X+4Y = 400
DL: 6X+6Y =240
Optimal Pt:
X=10, Y=30
DM: 16X+4Y=400 = 50
MC H: 3X+10Y=330
DL: 6X+6Y = 240
X=10; Y=30
Y = 12
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Limiting Factors
Slack: Example
Solving the equations:
Where optimal production occurs (from graph):
Mc H : 3X + 10Y = 330 (x2)
DL: 6X + 6Y = 240
6X+20Y =660
6X+6Y =240
14Y =420
Y=30; X=10
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Limiting Factors
Slack: Example
Substitute X=10, Y=30, into the constraint equations:
Mc H : 3X + 10Y = 330
(3x10)+(10x30)=330=availability
Constraint is binding
DL: 6X + 6Y = 240
(6x10)+(6x30)=240=availability
Constraint is binding
D M: 16X +4Y = 400
(16x10)+(4x30)=280<400
There is slack of 120kg of DM
More units can be produced if there is
more machine and labour hours available
since there are slacks in materials
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$urpIus refers to a situation where at optimaI
production:
the units of a product produced:
is more than the maximum demand
In the exampIe, there is a surpIus of 18 units of
Y (30 - 12) produced over the max of 12 units
Limiting Factors
Surplus
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uItipIe Limiting
Factors:
$hadow Price
(duaI price)
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$hadow price refers to:
an opportunity cost of having ON extra
unit of binding scarce resource O#
The increase in vaIue created by having
ON extra unit of binding scarce
resource at the originaI cost O#
The extra contribution or profit that may
be earned if ON extra unit of a binding
scarce resource is avaiIabIe
Limiting Factors
Shadow (dual) price
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$hadow price :
is the increase in contribution from the
originaI
Is the price of a scarce resource that a
company is wiIIing to pay for
over and above the present price -
stiII obtain a contribution towards its
fixed costs
No shadow price for resources which is
not binding - in excess
Limiting Factors
Shadow (dual) price
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Limiting Factors
Shadow price: Example (Example 10 pg86)
Product X Y Max
Selling Price/u 200 250
DM ($5/kg) $ 60
12kg
40
8kg 540,000kg
DL ($10/H) $ 50
5H
80
8H 400,000H
OH ($) 60 90
Total ' Cost ($) 170 210
Contribution/u $ 30 40
Demand (U) all
Max 40,000
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Limiting Factors
Shadow price: Example (Example 10 pg86)
dentify objective variable and determine
objective function :
X, Y < 0, Y > 40,000
D M: 12X + 8Y > 540,000
D L: 5X + 8Y > 400,000
Z = 30X + 40Y (maximise profit)
Substitute into equations and present in graph
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Limiting Factors
Shadow price: Example (Example 10 pg 86)
Graphical method:
Show the constraint
objective and
feasible region on
a graph:
Y = 40,000
DM: 12X+8Y = 540,000
DL: 5X+8Y =400,000
Z=30X+40Y
Opt point:
Y=40,000
DM 12X+8Y=540,000
DL 5X+8T=400,000
X=20,000; Y=37,500
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Limiting Factors
Shadow price: Example (Example 10 pg 86)
Solving the equations:
Where optimal production occurs (from graph):
DM : 12X + 8Y = 540,000
DL: 5X + 8Y = 400,000
7X = 140,000
X = 20,000
Y = 37,500
Z = $600,000+$1,500,000=$2,100,000
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Limiting Factors
Shadow price: Example (Example 10 pg 86)
Substitute X and Y value into the constraint
equations:
Where optimal production occurs:
DM : 12X + 8Y = 540,000
240,000 + 300,000 = 540,000
(binding)
DL: 5X + 8Y = 400,000
100,000 + 300,000 = 400,000
(binding)
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Limiting Factors
Shadow price: Example (Example 10 pg 86)
Shadow price of DM if one extra unit of DM is
available:
DM : 12X + 8Y = 540,001
DL: 5X + 8Y = 400,000
7X = 140,001
X = 20,000.14 x $30 = $ 600,004.2
Y =37,499.91 x $40 = $1,499,996.4
Revised contribution $2,100,000.6
Original contribution $2,100,000.0
ncrease in contribution $0.6
Shadow price of DM = $0.6 / kg
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Limiting Factors
Shadow price: Example (Example 10 pg 86)
Shadow price of DL if one extra unit of DL
hour is available:
DM : 12X + 8Y = 540,000
DL: 5X + 8Y = 400,001
7X = 139,999
X = 19,999.86 x $30 = $ 599,995.7
Y =37,500.21 x $40 = $1,500,008.4
Revised contribution $2,100,004.1
Original contribution $2,100,000.0
ncrease in contribution $4.1
Shadow price of DL = $4.1 / H
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Limiting Factors
Shadow price: Example (Example 10 pg 86)
Shadow price mplication:
Any binding scarce resource in the optimal solution
have a shadow price
Used to make decision if an existing resource should
be relieved of its effective value to the business
Only valid for a small range before the constraint
becomes non-binding, or different resources become
critical
A significant change would call for a revision in the
level of resources, and a new shadow price will be
created
t allows better informed decisions on payment of
overtime premiums, bonuses, premiums on small
orders of DM
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Limiting Factors
Other issues
Other issues
n the short run, management should find ways to
overcome the constraints
Look for substitutes
Work overtime
Rent more space
n the long run, management should remove the
limiting factor
However, another limiting factor will surface once
one is removed
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Limiting Factors:
Practice Questions
(pg 90)
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Limiting Factors
Q1 pg 90
Co produce 2 products, X & Y
Use 2 machines
Machine A: 3X+2y > 18
Machine B: X+2Y > 10
Z=5X+4Y
Substitute into equations:
McA: 3X+2Y=18
McB: X+2Y=10
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Limiting Factors
Q1
Graphical method:
Show the constraint
objective and
feasible region on a
graph:
Mc A:3X+2Y = 18
Mc B: X+2Y = 10
Z=5X+2Y
Total Contribution =
20+12=32
Mc A: 3X+2Y = 18
Mc B: X+2Y = 10
X=4, Y=3
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Limiting Factors
Q2 pg 90
Equation method:
McA: 3X+2Y=18
McB: X+2Y=10
2X=8
X=4, 2Y=6, Y=3
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Limiting Factors
Q3 pg 90
X Y Max
S Price ($/u) 220 206
DML ($6/Lit) 30
5Lit/u
36
6Lit/u
24,000 Lit (1
st
3 mth, &
2
nd
3 mth)
DMM ($7.5/Lit) 45
6Lit/u
30
4Lit/u
24,000 Lit (2
nd
3 mth
only)
'OH 55 44
Total 130 110
Contribution ($/u) 90 96
Contribution/Ltd
Factor ($/u)
18 16
Rank 1 2
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Limiting Factors
Q3 pg 90
(a) Optimal production plan:
Allocate all DML to X with the highest
Contribution/limiting factor
24000Lit / 5Lit per unit = 4,800 of X
Total contribution for producing 4,800 of X
= $432,000
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Limiting Factors
Q3 pg 90
(b) Optimal production plan:
Formulate equations for constraints:
DML: 5X+6Y=24000 (x2)
DMM: 6X+4Y=24000 (x3)
10X+12Y=48000
18X+12Y=72000
X=3000: Y=1500
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Limiting Factors
Q4 pg 90
AR2 GL3 HT4 Max
S Price ($/u) 21.00 28.50 27.30
DM R2 (kg/u) 2 ($5) 3 ($7.5) 3 (7.5) 5500kg
DM R3 (kg/u) 2 ($4) 2.2 ($4.4) 1.6 ($3.2)
DL (H/u) 0.6 ($2.4) 1.2 ($4.8) 1.5 ($6)
'OH ($/u) $1.10 $1.30 $1.10
FOH ($/u) 1.50 1.60 1.70
Demand 950 1000 900
Contribution / u $8.5 $10.5 $9.5
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Limiting Factors
Q4 (a)
AR2 GL3 HT4 Max
Contribution / u $8.5 $10.5 $9.5
DM R2 (kg/u) 2 3 3 5500kg
Contribution / u R2 $4.25 $3.5 $3.17
Ranking 1 2 3
DM R2 Allocation 1900kg 3000kg 600kg 5599kg
Prod Plan 950 1000 200
Total Contribution $ 8075 10500 1900 $20475
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Limiting Factors
Q4 (b)
4(b) Shadow price of DM R2:
Extra unit of R2 will go to produce HT4:
1 extra kg R2 can produce extra 0.33 unit of HT4
= (1kg/3kg per unit HT4)
Extra contribution for 0.33 units HT4 = $3.14
Shadow price for R2 = $3.14
Max price to offer for extra R2 = $5.64 /kg
($2+$3.14)
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Limiting Factors
Multiple Limiting Factors