In my last post, I continued my series on throughput accounting and discussed organizational paradigms that must be considered. Specifically, I focused on two distinctly different accounting paradigms with one being cost-focused and the second one being throughput-focused.
Here in Part 4, I will present throughput accounting calculations and performance measures. I will demonstrate why businesses should be using throughput accounting to make real-time decisions. As mentioned previously, throughout this series, I will continue to reference a book I highly recommend, entitled Throughput Accounting Techniques by Etienne Du Plooy(1).
Understanding the reasons for using performance measures
The primary reason for using measurements is that we want to know how our system is performing, so what we measure is one of the keys to success. We need to understand that our method for measuring systems, people, machines, and other measurables affects the financial results we achieve. It’s clear that systems need people to perform, so traditionally people are measured. It’s also clear that people behave according to the measurements on which they are evaluated.
Every measuring method used looks at three key areas, namely:
- How people behave
- How resources are used
- How systems perform
Throughput accounting performance measures
Measuring performance with throughput accounting is a simplified way of obtaining information and describing how a system is performing. Throughput accounting (TA) measures results in a way that is designed to drive behavior with intended consequences, because it links local behavior to global systemic behavior.
TA uses three basic measurements as follows:
- Throughput (T): The rate at which the system generates money and uses the formula: T = Net Sales (NS) – Totally Variable Costs (TVC) or T=NS – TVC
- Investment (I): Investment includes all of the money in the system including inventory of raw material, work-in-process, and finished goods valued as TVC.
- Operating Expense (OE): OE is all of the money a system spends in generating “goal units,” and includes things like salaries and wages, insurance, and rent over a relevant time period.
From these three basic measurements we can then calculate Net Profit (NP) and Return on Investment (ROI) as follows:
- Net Profit (NP) = Throughput (T) – Operating Expense (OE) or NP = T – OE
- Return on Investment (ROI) = Net Profit (NP) / Investment ( I ) or NP/I
We can also calculate other measures such as Productivity as follows:
- Productivity (P) = Throughput (T) / Operating Expense (OE) or P = T/OE
In his book, Etienne Du Plooy discusses many other performance measures that can be calculated to help make real-time decisions. The metrics used in throughput accounting may appear similar to traditional metrics, but the differences are aimed at improving performance the throughput accounting way.
Although TA is defined differently from Generally Accepted Accounting Practices (GAAP), the key is how we relate to the measurements. At the end of the day, Net Profit and Return on Investment are the measurements that tell you if your performance is acceptable. Both NP and ROI are influenced by throughput and operating expenses. Traditionally, Operating Expenses are what cost-oriented thinking focuses on most. In TA, changes in throughput are what tell us if we are on track to reaching our goal.
Coming in the next post
In my next post, I will complete our discussion on accounting practices and offer some of the keys to a successful implementation of throughput accounting.
Meanwhile, to learn more on throughput accounting practices in a manufacturing environment, check out the series Throughput Accounting for Manufacturers.
Until next time,
(1)Etienne Du Plooy, Throughput Accounting Techniques, General Media Press, Garsfontein, South Africa, 2016
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