Sales Limiting Factors

What are Limiting Factors?

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In management accounting, limiting factors refer to the constraints in availability of production resources (e.g. shortages in labour, machine hours or materials) that prevent a business from maximising its sales.

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Single Limiting Factor Analysis

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If an organisation manufactures more than one product and faces a shortage in the supply of a single resource (e.g. labour hours, machine hours or a material) that is required in the production of its multiple products, what quantities of its various products should be produced to maximise profits?

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One option would be to determine production quantities on the basis of contribution per unit of the different products (i.e. products with higher contribution per unit shall be given preference over products with lower contribution per unit).

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Prioritising production on the basis of contribution per unit however would not maximise profits as the approach fails to take into account the contribution of various products relative to their usage of the limiting resource which shall ultimately determine the overall profit. Therefore, when facing a situation involving a single limiting factor, products should be prioritized in the production plan according to their contribution per unit of the limiting resource.

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Six Step Approach

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Single limiting factor problems can be solved by adopting the following six-step approach.

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Step 1: Determine the maximum sales

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In order to calculate whether a limiting factor exists (Step 2), we need to ascertain the maximum sales that the business can achieve ignoring any limiting factors that affect production of multiple products.

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In most cases, Maximum Sales will equal to sales demand of the respective products of the company.

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However, if there is any limiting factor specific to a product (i.e. the limiting factor only affects production of one product rather than multiple products) the Maximum Sales of that product should not exceed the units of production that will be achievable subject to such limitation.

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See Step 1 of Example below for an illustration of this step.

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Step 2: Determine the limiting factor

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Here we need to establish which factor is responsible for limiting the production of its various products.

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This can done by simply comparing:

a) Available units of factors
b) Units of factors required to achieve the Maximum Sales calculated in Step 1

If there is however a shortfall in more than one units of resource (i.e. multiple limiting factors), then the problem can only be solved using linear programming techniques.

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Step 3: Calculate contribution per unit of output of each product

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Contribution is simply selling price less variable costs.

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As with most short term decisions in managerial accounting, fixed costs are non-relevant which is why the limiting factor analysis uses contribution per unit rather than profit per unit.

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Step 4: Calculate contribution per unit of limiting factor for each product

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This represents the contribution earned from a product for every unit of scarce resource consumed.

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Step 5: Rank products in order of priority

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The product with highest contribution per unit of limiting factor calculated in Step 4 shall be ranked first whereas the second highest shall be ranked second and so on.

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Step 6: Calculate production quantities

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Product ranking first in Step 5 would be produced up to the maximum sales subject to the availability of the limiting resource. Lower ranked products shall only be produced if the entire production requirement of higher ranked products have been met.

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