Review of Throughput Accounting for Manufacturing Organizations, Part 1
In Part 1, I discussed the basics of both cost accounting and throughput accounting. I also provided a brief section on the history of both of these accounting methods and explained why I believe that throughput accounting should be used by more companies.
Part 2 continues with these two different accounting systems that are both used to maximize profitability within your company. In order to better understand throughput accounting, an understanding of constraints theory is necessary.
In this series, I will be 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.
Types of constraints
Constraints are those things within the system that limit or prevent something from happening and ultimately limit a system from achieving its goal or objective. There are a large variety of constraints (aka, bottlenecks), that exist within many organizations so let’s look at a few of the more common ones:
- Physical constraint: Typically seen as a process step with limited capacity that prevents a system from reaching its goal.
- Process constraint: A set of actions or steps taken to achieve a given result. Process constraints contain one or more of these steps and are very similar to physical constraints.
- Cash constraints: A severe lack of cash that prevents a system from achieving its goal. It is typically regarded as a physical constraint. Cash constraints are those where the capacity of cash is insufficient for a system to operate as it should.
- Market constraint: A condition where the global market demand is less than the organization’s capacity to sell its products or services.
- External constraint: This type of constraint is located outside the system such as a customer or government policy.
These are just some of the types of constraints that exist within many organizations that hinder your ability to maximize your company’s profitability.
A constraint can be something as simple as a machine or person, or it can be more complex such as a company policy. The key is to be able to locate the constraint so action can be taken to counter its negative effects.
You may be wondering if a system can have more than one constraint. In today’s complex business systems, it’s not unusual to have several constraints which individually or collectively limit the system from achieving its goal.
Considering that a system may have multiple, concurrent constraints, improving all constraints simultaneously or picking one at random can be challenging and confusing. With this in mind, the greatest leverage occurs when the constraint being improved is the singular system constraint. This is because its attributes have the potential of leveraging the system’s decisive competitive advantage. The system constraint is the constraint which ultimately determines the system’s performance.
In throughput accounting, a strategic constraint is the chosen constraint that aligns the system’s strategy with the system’s goal. Instead of current demands on the system dictating where the constraints currently are, management decides where a strategic constraint should be, because focusing efforts on the chosen strategic constraint will bring the system closer to its strategic goal in the medium to long-term future.
Budgets and forecasts
Although many organizations do not prepare budgets, those that do prepare them with little or no regard for constraints. Aligning a budget and a forecast to the system constraint makes goal setting and attainment much more focused than using a traditional cost-based accounting approach. Measuring deviations from the goal and identifying their causes allows for corrective action to be applied sooner than with traditional methods.
Traditional budgets can still be compared to actual results, and so can throughput accounting budgets. Differences can still be analyzed from both cost-based and throughput-based approaches. Having throughput-based and cost-based intelligence is very powerful in the right hands.
Coming in the next post
In Part 3 of this series, I will continue our discussion on accounting methods and look at some of the reasons why throughput accounting can help companies significantly improve their profitability.
In the meantime, if you would like to read a Case Study on the application of Theory Constraints, please see my Blog post series titled A Theory of Constraints Case Study.
Until next time,
(1)Etienne Du Plooy, Throughput Accounting Techniques, General Media Press, Garsfontein, South Africa, 2016
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