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Throughput Accounting
Organisational Excellence > Cost Management / Throughput Accounting
Throughput Accounting is a management accounting technique used as the performance measures in the Theory of Constraints. It is the business intelligence used for maximizing profits. Unlike cost accounting that primarily focuses on 'cutting costs' and reducing expenses to make a profit, Throughput Accounting primarily focuses on generating more throughputs. Conceptually, Throughput Accounting seeks to increase the velocity or speed at which throughput is generated by products and services with respect to an organisation's constraint, whether the constraint is internal or external to the organisation.
Throughput Accounting focuses on increase revenue (throughput), improving cash flow (investment) and providing capacity (operating expense). Every management decision is made based on expected changes in throughput, investment and operating expense. Throughput Accounting allows managers to take a more balanced approach to decision making, giving an accurate picture of the results of decisions.
This approach differs substantially from Traditional Costs Accounting because the company is not focused on every machine and employee working at optimal efficiency. Instead, the basis is that if a company optimises any non-constraint, it will overload the constraint and create excess inventory. Throughput Accounting is thus part of the management accountants' toolkit, ensuring efficiency where it matters as well as the overall effectiveness of the whole organisation. It is an internal reporting tool.
Throughput Accounting provides a way to measure productivity improvement efforts based on how they affect cost and throughput. It can be applied to decisions that affect all aspects of a company including product price, process improvement, reward structures, investment justification, transfer pricing and performance management. The result is a thorough understanding of how a company is functioning as a whole and the ability to analyse the true impact of management decisions before they can be made.
Process Improvement – A Case Study
Sunshine Pte Ltd produces parts for automotive. Its primary measure of productivity is labour absorption under the assumption that if more work is being done to create inventory, profits will increase. However, using this measure resulted in actions to increase inventory and build stock products rather than fill actual customer orders.
Process improvements (like Lean Sigma initiatives) were implemented to reduce costs. Efforts were made to decrease the labour involved in producing parts. This was done for all operations. Many non-constraints became faster, producing even more work than the constraints could handle. Even though labour went down, inventory increased and it became more difficult to fulfil orders on time and to properly prioritize manufacturing jobs.
When management learned about throughput, it shifted its focus from absorbing costs into inventory to increasing how quickly work could be completed. Emphasis was given to improving constraints. By investing $89,000 in the facility and adding 3 additional workers to the day shift, output increased by 83%. Under traditional Cost Accounting, these expenses would not have been justified because local output efficiency would have declined on a per labour hour basis. However, the cost was minimal compared to the increase in throughput.
If you would like to learn more about Throughput Accounting, why not consider our Training Workshop or customised Consultancy services?
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