Implementing Throughput Accounting

 

Enterprises may be apprehensive when confronted with the unknown ramifications of implementing a new system or business intelligence technology, implementing Throughput Accounting is not different. The questions below are sometimes asked. Here are Etienne Du Plooy’s responses on TPACC. Please contact us if you need any clarifications or wish to discuss any topic.

 

1

Is Throughput Accounting applicable to small and large enterprises?

Yes, Throughput Accounting assists managers to improve the performance of any enterprise¹ size. Throughput Accounting mostly measures Throughput, Investment, and Operating Expenses, of an enterprise, but their power lies in the interaction of all three. Its measurements are used to manage an enterprise towards its goal, and greatly supports decisions that will improve performance of all sizes of enterprises.

 

¹ Systems include the following forms of entities: enterprise, business, organization, institution, firm, company, conglomerate, partnership, and any other form of a system with a goal, whether for-profit or not.

2

Does every enterprise have constraints?

Yes, at least one. Throughput Accounting, as its name suggests, measures the Throughput of constraints that limit and determine the performance of an enterprise. Even though an enterprise thinks it has unlimited capacity to meet its market demand, at any point in time there is a constraint that slows down Throughput. The Theory Of Constraints hypothesizes that constraints determine the performance of a system. Even when the capacity of resources an enterprise invests in is unlimited, at least one constraint limits its performance. Identifying and measuring the Throughput of all resources enables the identification of constraints and supports decisions that improve the enterprise. Many enterprises don’t have certainty of their constraints. Picking one is far better than not picking one, no matter if it’s internal or external of the enterprise, under its control or not, or invested in or not.

3

What does “Throughput” mean?

In Throughput Accounting, Throughput is the rate of money generated by an enterprise, and calculated as the rate of Net Sales less Totally Variable Costs for the SKUs² for units of products or services sold. This is a fundamental concept³ of Throughput Accounting. The term “Throughput” in a business performance sense, was originally coined by Dr Eliyahu Goldratt, and later defined in his remarkable book, The Goal⁴. An enterprise, or any system, measures its Throughput because if it knows the current rate, it can try to improve it in the future.

 

² SKU is an abbreviation for Stock Keeping Unit.

³ Etienne Du Plooy, Throughput Accounting Techniques. The sixth fundamental concept of Throughput Accounting.

⁴ Eliyahu M. Goldratt and Jeff Cox, (2004) The Goal, 3rd Ed, North River Press. ISBN 0620335971.

4

Is Throughput Accounting implemented differently in small and large enterprises? 

No, the size of an enterprise does not determine what to leave-out, or what to add-in when it is implemented. From the smallest spreadsheet sized coffee shop enterprise, to large multi-national ERP⁵ enterprises, the principles are the same. The scope or scale of an implementation may differ, i.e. implementations are either large, medium, or small.

Compared to traditional management accounting, which breaks-up an enterprise into smaller parts, e.g. cost centers or activity departments to try to improve the efficiency of each part, Throughput Accounting is a holistic approach, designed to improve any enterprise in its entirety, because it conforms to the principles of the Theory Of Constraints, which state that at any one point in time at least one constraint limits an enterprise from reaching its goal.

 

⁵ ERP is an abbreviation for Enterprise Resource Planning.

5

Why do we need Throughput Accounting?

Every enterprise wants to perform successfully, but the desired level of successful performance is not always achieved. Failures happen and net losses result. One hears success stories: of department costs being saved, more customers being satisfied, or, less inventory holding being required. But, one seldom hears by how much the total profits actually changed due to the efforts. With Throughput Accounting, enterprises review the outcomes of alternative decisions before they are made. The most profitable alternative may not always be selected, but Throughput Accounting provides the knowledge of what that alternative is. Throughput Accounting’s unique ability of measuring whether a strategy or tactic brings an enterprise closer to its goal, is why we need it. Throughput Accounting just ticks all the right boxes for enterprises that want to continuously improve.

6

What does Throughput Accounting need for it to work?

Throughput Accounting uses a unique combination of non-accounting and accounting data. The primary measure of enterprise performance is Throughput. The concept of Throughput is the rate of money generated by an enterprise. It thus follows logically that if constraints determine a systems’ performance, identifying the constraints is the first step to be taken. This is where the Theory Of Constraints steps in and identifies enterprise constraints. After that, Throughput Accounting cycles through steps similar to a Control Feedback Loop or OODA Loop⁶. After quantifying the enterprise’s goal in Net Profit terms, Throughput Accounting compares actual data with that goal. Readers that know the Theory Of Constraints, know the process of on-going improvement, where Throughput Accounting plays an important role in the exploitation of constraints because they determine the success of an enterprise.

The data required for Throughput Accounting includes enterprise operating data, e.g. resource capacities, as well as accounting data, e.g. net sales and totally variable costs, which are Throughput based as opposed to traditional Cost Accounting based. A key difference between Throughput Accounting and Cost Accounting, is that Throughput Accounting does not allocate Operating Expenses to products and services. In other words, traditional overheads are not absorbed into inventory values. The use of Throughput based data allows Throughput Accounting to provide information that is relevant to the change that continuously takes place in an enterprise. E.g. Throughput Accounting confirms or warns enterprises that their goals may or may not be achieved. When change happens, the change is analyzed. The measures of Throughput Accounting reveal information that focuses on improving Throughput where it matters most for the entire system. The feedback restarts and focuses on a new constraint, as in a continuous improvement cycle.

 

⁶ OODA Loop is an abbreviation of the process of: Observe – Orient – Decide – Act, created be United States Air Force Colonel John Boyd.

7

What are the basic measures of Throughput Accounting?

The common metrics used in Throughput Accounting are:

•  Throughput,

•  Investment,

•  Operating Expenses,

•  Net Profit,

•  Return On Investment, and

•  Cash Flow.

These metrics may sound simple, however their power should not be underestimated because they work together as a well oiled machine. Each has a desired direction, e.g. Throughput should increase but Operating Expenses should decrease. The first three are prioritized, and when all change in their desired direction, the enterprise moves closer towards its goal at a faster pace.

8

How much effort is required to implement and maintain Throughput Accounting?

Implementing Throughput Accounting is totally dependent on the scope. It is quicker to implement Throughput Accounting in a small enterprise, whilst a large ERP implementation takes more effort, and thus it takes longer. In general, compared with costing systems the effort to implement Throughput Accounting is less. Maintenance is also less, and in many cases considerably less than costing systems with high levels of complexity. Throughput Accounting does not always replace all costing systems, i.e. where a costing system is required for legal reasons, e.g. for submitting government import duty claims. The larger the scope, the more the effort required.

9

What are the difficulties that could arise in a Throughput Accounting implementation?

Measuring enterprise performance success involves comparing an enterprise’s current performance with its goal. Whatever the change, it is as a result of decisions which led to the actions taken. The metrics used in Throughput Accounting may appear similar to traditional metrics, but the technical differences are what distinguish them. In Throughput Accounting, the change in Throughput is the primary measure that tells us if we are on track to reaching the goal. However, Throughput is a rate that is subject to the constraints of an enterprise. Each time a product or service is sold or returned, Throughput changes. Throughput is inflowing revenue of net sales, less outflowing totally variable costs. Determining totally variable costs can be challenging at times, however, there has always been a way to overcome this obstacle. As Throughput is not just a value, but it is a rate, this distinction is generally misunderstood. Throughput has a speed, whether its value is determined by sales of SKU’s, by contractual agreements, or by pay-per-click. Although Throughput Accounting uses different definitions compared with Generally Accepted Accounting Practice (GAAP), the key to implementing Throughput Accounting successfully, is how well the concepts of Throughput Accounting are understood. If an enterprise overcomes this key obstacle, Throughput Accounting gives us benefits no other approach can.

10

What are the benefits of using Throughput Accounting?

The key benefit is to have the information Throughput Accounting provides. With the information, focused tactical decisions can be made, as well as long-term strategy planning. This information gives an enterprise, business intelligence that improves its competitive edge. There are many uses for this information. Although every system is unique, here are a few uses of what is possible:

•  Improve ROI (Return on Investment).

•  Improve enterprise profits.

•  Improve customer mixes.

•  Improve the mix of products and services offered to the market.

•  Improve productivity of the enterprise.

•  Learn and adapt how constraints determine the performance of organizations.

•  Understand variation, its causes and its affects.

•  Build achievable budgets, forecasts, plans, & strategies.

•  Create models that project enterprise Throughput into the future.

•  Design products that customers actually want.

•  Monitor distribution channel Throughput speeds.

•  Combine LEAN principles with the Theory Of Constraints and other continuous improvement approaches.

•  Make a significant impact on enterprise wealth creation.

•  Improve the productivity of entire supply chains.

•  See why inefficiencies don’t always loose money.