Throughput Accounting

17 December 2006 |

Throughput accounting (TA) is an alternative to cost accounting proposed by Eliyahu M. Goldratt. It is not based on Standard Costing or Activity Based Costing (ABC). Throughput Accounting is not costing and it does not allocate costs to products and services. It can be viewed as business intelligence for profit maximization. Conceptually throughput accounting seeks to increase the velocity at which products move through an organization by eliminiating bottlenecks within the organization.


Cost (or Management) accounting is an organization's internal method used to measure efficiency. Since no one outside the organization uses such internal accounts for investment or other decisions, any methods that an organization finds helpful can be used.


Throughput accounting improves profit performance with better management decisions by using measurements that more closely reflect the effect of decisions on three critical monetary variables (throughput, inventory, and operating expense — defined below



The concept of throughput 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:
  1. Increase Throughput? How?
  2. Reduce Investment (Inventory) (money that cannot be used)? How?
  3. Reduce Operating expense? How?


The answers to these questions determine the effect of proposed changes on system wide measurements:
  1. Net profit (NP) = Throughput - Operating Expense = T-OE
  2. Return on investment (ROI) = Net profit / Investment = NP/I
  3. Productivity (P) = Throughput / Operating expense = T/OE
  4. Investment turns (IT) = Throughput / Investment = T/I


Managers intent on maximizing throughput can employ TOC's five focusing steps which allow them to move the firm toward the achievement of the goal. The five steps are as follows:


1. Identify the system's constraints.
2. Exploit the system's constraints.
3. Subordinate everything else to the decision made.
4. Elevate the system's constraints.
5. Restart the process if a constraint has been broken.


Identify the constraint is to compare resource availability with resource requirements. In the Constrained Company there are four resources, Workers A-D. First consider the load placed on Worker A. As noted in the Exhibit, Product Y requires 15 minutes of Worker A's time, while Product Z requires 10 minutes. Since the potential demand for Products Y and Z are 100 units and 50 units, respectively, total Worker A time required to manufacture both Products Y and Z is 2000 minutes ((15 minutes/unit x 100 units) + (10 minutes/unit x 50 units)). Since there are 2400 minutes available each week for each worker, Worker A is not the constraint.


Next, consider the load placed on Worker B. Again referring to the table, the total Worker B time requirement for the production of 100 units of Product Y and 50 units of Product Z is 3000 minutes. Worker B with a weekly deficiency of 600 minutes represents a constraint. Similar calculations for Workers C and D show that neither worker is a constraint. In both cases, then, resource load or time required (1750 minutes) is less than resource availability (2400 minutes).


Exploit the System's Constraint(s). Constrained Company cannot satisfy market demand for both Products Y and Z. To move the firm toward the goal, management must exploit the constraint. Exploit means to squeeze the maximum amount of throughput out of the constraint. The constraint is the labor minutes of Worker B. The first step in exploiting the constraint is to calculate the amount of throughput for one unit of each of the two products. Throughput for Product Y is $75/unit and $120/unit for Product Z . To exploit the constraint, management must know how many minutes of constrained resource are required to get a dollar of throughput. Focusing only on Worker B, product Y throughput per minute is $5 ($75/15 minutes). For product Z, throughput per minute of Worker B time is $4 ($120/30 minutes). Given that the constraint is Worker B time, Constrained Company should manufacture 100 units of Product Y and only 30 units of Product Z. This product mix will consume all of the available minutes of Worker B's time. Total throughput will be ($75/unit x 100) units + ($120 x 30) units = $11,100. Net profit is $1,100 ($11,100-$10,000).

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Further Reading on Throughput Accounting




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