Manufacturing ERP Software
Categories: Accounting Methods
Throughput Accounting for Manufacturing Organizations, Part 5

Throughput Accounting for Manufacturing Organizations, Part 5

By Bob Sproull

Review of Throughput Accounting for Manufacturing Organizations, Part 4

Part 4 of this series covered general performance measures, how they are used to measure behavior, how resources are used, and how systems perform. From there, the focus shifted to throughput accounting measures and how these key metrics are calculated.

I will complete this exploration of accounting practices and discuss some of the keys to a successful implementation of throughput accounting, as well as the potential benefits a company can realize in Part 5. Throughout this series, I have been referencing a book entitled Throughput Accounting Techniques written by Etienne Du Plooy(1). For everyone who has not read this book, I highly recommend it.

Implementing throughput accounting

Enterprises may be apprehensive when confronted with the unknown implications of implementing a new system and throughput accounting falls into this uneasiness. My clients have often asked whether throughput accounting is applicable to small and large companies. It is absolutely applicable, and deserves strong consideration. Throughput accounting supports managers who want to improve the performance of any sized company.

As I discussed in my last post, throughput accounting measures throughput, investment, and operating expenses of a company. The real power of this method lies in the interaction of these measurements. Throughput accounting’s measurements are used to manage any sized company toward the goal of making more money now and in the future, and it supports decisions that will move companies toward this objective.

What does “throughput” mean?

Throughput is the rate of money generated by a company. It is calculated as the rate of net sales minus totally variable costs for the SKUs or units of products or services sold. This is a basic concept of throughput accounting. Once managers identify the current rate of throughput, by using this method, they can then focus on improving it in the future. The way companies can improve throughput is to identify their constraints and work to improve flow through them.

Does every enterprise have constraints?

I get asked this question often in my consulting projects and my answer is “Yes, at least one.” Throughput accounting, as the name suggests, measures the throughput of constraints that limit and determine the performance of any company.

Even though a company’s decision-makers might believe they have unlimited capacity to meet market demand, at any point in time, there is always a constraint that slows down throughput generation. The Theory of Constraints postulates that constraints determine the performance of the total system. So even when the capacity of resources a company 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 all decisions that will improve the profitability of any company.

Is throughput accounting implemented differently in small and large enterprises?

No, to quote Etienne Du Plooy[i], “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 multinational ERP enterprises, the principles are the same. The scope or scale of an implementation may differ, i.e., implementations are either large, medium, or small.”

Whereas comparing traditional management accounting 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 uses a holistic approach. It is designed to improve the entire company because it conforms to the principles of the Theory of Constraints, which tells us that at any one point in time, at least one constraint limits any company from reaching its goal.

Why do we need throughput accounting?

Every company wants to perform successfully, but this ambition is not always achieved. Typically, we hear success stories of department costs being saved, more customers being satisfied, or, less inventory holding, but one thing we don’t hear often is how much the total profits actually changed due to the improvement efforts. With throughput accounting, companies can actually review the outcomes of decisions before they are made. The most profitable alternative may not always be selected, but throughput accounting provides the knowledge of what that alternative should be, given its expected outcome. Throughput accounting’s exclusive ability to measure whether a particular strategy brings a company closer to its profit goal is the reason why we need it.

What does throughput accounting need for it to work?

Throughput accounting uses a unique combination of non-accounting and accounting data with the primary measure of company performance being throughput. As stated previously, throughput is the rate of money generated by a company. It follows logically that if constraints determine a system’s performance, identifying the constraints is the first step to be taken. This is where the Theory of Constraints steps in to identify company constraints. After quantifying the company’s goal in net profit terms, throughput accounting compares actual data with the goal.

The data required for throughput accounting includes company operating information such as   resource capacities and accounting data, including net sales and totally variable costs. These types of data are throughput-based as opposed to traditional cost accounting-based. One of the key differences between throughput accounting and cost accounting is that throughput accounting doesn’t allocate operating expenses to products and services, meaning that 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 any company in real-time. When change happens, the change is analyzed and 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.

What are the benefits of using throughput accounting?

The key benefit of using this methodology is to have better information upon which to base business decisions. With this information, businesses can make focused, tactical decisions in real-time, as well as long-term strategic planning decisions. This information gives an enterprise business intelligence that improves its competitive edge. Although every system is unique, here are a few possible objectives companies can set using throughput accounting:

  • Build achievable budgets, forecasts, plans, and strategies
  • Improve ROI
  • Improve company profits
  • Improve product and service mix
  • Improve enterprise productivity
  • Combine Lean and Six Sigma principles with the Theory of Constraints and other continuous improvement approaches

Coming in the next post

The next post will be the start of a new series on manufacturing improvement methodologies.

For more on accounting methods used in manufacturing, check out the post Cost Accounting vs. Throughput Accounting.

Until next time,

Bob Sproull

 

References:

[i] Etienne Du Plooy, Throughput Accounting Techniques, General Media Press, Garsfontein, South Africa, 2016

Bob Sproull

About the author

Bob Sproull has helped businesses across the manufacturing spectrum improve their operations for more than 40 years.

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