When Professor Ing. Adolf Held (MBA) presented in 2001 the topic Thoughput accounting I was a bit more than fascinated. Nowadays it’s still seems to me one of the most important management models, because you could use it for a bunch of different things. While lean accounting based on cost is focused in minimize the cost of capacity, throughput accounting is focused on maximize de use of capacity.
The Theory of Constraints, a management philosophy derived from physics, assumes that constraints prevent organizations from achieving better performance. The Theory of Constraints (TOC) is based on a scientific method that has been developed and refined for nearly three decades by Dr. Eliyahu M. Goldratt. As a tool for business management, it is now accepted as a mainstream alternative to cost accounting. Throughput Accounting…
• Reveals a new management tool for managerial accounting and shows an alternative path for other management practices.
• Enables managers to quickly see if their decisions increase profitability.
• Demonstrates some of cost accounting’s flaws, and shows how these errors will lead to
bad decision making.
• Compares the paradigm of TOC-based throughput accounting with more conventional cost accounting methodologies and in the process, demonstrates a new way to solve the complex problems of modern management.
• “TOC is radically different from traditional accounting methods taught in universities,
the focus is on finding the highest price that the market will bear and maximizing
throughput dollars, not cost-plus accounting.”
Goldratt’s alternative begins with the idea that each organization has a goal and that
better decisions increase its achievement that value. The goal for a profit maximizing
firm is easily stated, to increase profit, now and in the future. Throughput accounting
applies to not-for-profit organizations too, but they have to develop a goal that makes
sense in their individual cases.
Throughput Accounting also pays particular attention to the concept of bottlenecks in the
manufacturing or servicing processes.
Throughput accounting uses three measures of income and expense:
• Throughput (T) is the rate at which the system produces “goal units.” When the goal
units are money (in for-profit businesses), throughput is sales revenues less the cost of
the raw materials (T = S – RM). Note that T only exists when there is a sale of the
product or service. Producing materials that sit in a warehouse does not count.
(“Throughput” is sometimes referred to as “Throughput Contribution” and has similarities
to the concept of “Contribution” in Marginal Costing which is sales revenues less “variable” costs – “variable” being defined according to the Marginal Costing philosophy.)
• Investment (I) is the money tied up in the system. This is money associated with
inventory, machinery, buildings, and other assets and liabilities. In earlier TOC documentation, the “I” was interchanged between “Inventory” and “Investment.” The preferred term is now only “investment.” Note that TOC recommends inventory be valued strictly on totally variable cost associated with creating the inventory, not with additional cost allocations from overhead.
• Operating expense (OE) is the money the system spends in generating “goal units.” For physical products, OE is all expenses except the cost of the raw materials. OE includes maintenance, utilities, rent, taxes, payroll, etc.
Organizations that wish to increase their attainment of The Goal should therefore require managers to test proposed decisions against three questions. Will the proposed change:
• Increase Throughput? How?
• Reduce Investment (Inventory) (money that cannot be used)? How?
• Reduce Operating expense? How?
The answers to these questions determine the effect of proposed changes on system wide measurements:
• Net profit (NP) = Throughput – Operating Expense = T-OE
• Return on investment (ROI) = Net profit / Investment = NP/I
• Productivity (P) = Throughput / Operating expense = T/OE
• Investment turns (IT) = Throughput / Investment = T/I
These relationships between financial ratios as illustrated by Goldratt are very similar to a set of relationships defined by DuPont and General Motors financial executive Donaldson Brown about 1920. Brown did not advocate changes in management accounting methods, but instead used the ratios to evaluate traditional financial accounting data.