Throughput Accounting (TA) can be understood as a simplified accounting system based on Theory of Constraints (ToC) principles. TA makes growth-driven management and decision making simpler and understandable even for people not familiar with traditional accounting.
Beyond simplifying, TA has a different approach compared to traditional accounting. The latter will focus on cost control (cost of goods sold) and minimizing the unit cost while TA strives to maximize profit.
Throughput Accounting sets the base for Throughput Analysis, helping to make decisions in the ToC way.
Throughput Accounting will probably not replace GAAP in short nor medium term, but provides a limited set of simple KPIs, sufficient to:
- Manage and make decisions in a growth-oriented and ToC way
- Allow faster reporting and near to real-time figure-based management
- Help people in operations to understand the basics of accounting
- Set a common base for controllers and operations to discuss decisions, investments, etc.
Throughput Accounting uses 3 KPIs and 2 ratios:
Throughput, defined as the rate of producing goal units (usually money) and translates as revenue or sales minus totally variable expenses in accounting terms.
Totally variable expenses can be simplified to the cost of direct materials because labor is nowadays paid on a (relatively) fixed amount per time period, hence a constant expense to be considered as part of Operating Expenses.
Operating Expenses (OE)
Operating Expenses are all expenses, except the totally variable expenses previously mentioned in the calculation of throughput, required to run and maintain the system of production. Operating Expenses are considered fixed costs, even so they may have some variable cost characteristics.
Investments, formerly call Inventories, is the amount of cash invested (formerly “tied”) into the system in order to turn as much of the Investments into Throughput as possible. This encompasses the stored raw material waiting to be transformed into sellable products as well as investments in capacities / capabilities to produce more units.
Net Profit (NP)
Net Profit is defined as Throughput minus Operating Expenses, or Sales – Total Variable Costs – Operating Expenses.
Return On Investment (ROI)
Return On Investment is the Net Profit compared to Investments (ROI = NP/I).
Drivers for achieving the Goal
Throughput Accounting offers a simplified way to identify and use the drivers to achieve the Goal, assuming the Goal is to make money now and in the future.
In a very simple way this can be summarized by the following picture which means strive to maximize Throughput while minimize the Operating Expenses and Investments.
ToC practitioners recognize that Throughput has no limit while Operating Expenses and Investments have limits beyond which no safe operations can be further envisioned.
The priority focus on improving T (focusing on the constraint exploitation) rather to go for all-out cost cutting explains the (usually) superior results when going the ToC way compared to unfocused improvements.
Throughput Accounting KPIs can be presented in a Dupont-inspired model in order to make the levers and consequences clear. (graphics to come)
Beyond the simplification compared to traditional accounting, Throughput Accounting sets the base for Throughput Analysis, helping to make decisions in the ToC way.
Reminder: in a system with a capacity constraint, the Throughput is limited and controlled by the sole constraint. As the capacity is fully used and no spare is available to exploit, what goes through the constraint must be chosen wisely in order to make the best use of this very precious resource.
It becomes obvious then that utmost attention must be paid to maximize the passing of the highest profit generating products through the constraint. The decision making is then based on the Throughput per constraint minute rate. The higher the T/mn, the better.
Other decisions Throughput Analysis helps to make are about anything likely to alter the Throughput, Operating Expenses or investments. Basically, any incremental increase of OE and/or I should lead to an incremental increase of T.
Conversely any decrease of OE and/or I should NOT lead to an incremental decrease of T.
This post is partly inspired by the work of Steven Bragg. I recommend his blog and post about Troughput analysis http://www.accountingtools.com/throughput-analysis