TOC FINANCE & MEASUREMENTS
Since cost accounting was a development of the 1920's, its logic often assumes average costs per part, average margin, etc… This can lead to opposite conclusions when determining which service or product is actually most favorable. Additionally it also impacts many parts of the organization as sales commissions tend to be based on "margins", ROI, efficiencies, etc…
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COST(LY) vs. THROUGHPUT ACCOUNTING...
Throughput (T) is the rate at which the system produces "goal units." When the goal units are money (in for-profit businesses), throughput is Net Sales (S) less Totally Variable Cost (TVC), generally the cost of the raw materials (T = S - TVC). Note that T only exists when there is a sale of the product or service. Producing materials that sit in a warehouse does not form part of Throughput but rather Investment. ("Throughput" is sometimes referred to as "Throughput Contribution" and has similarities to the concept of "Contribution" in marginal costing which is sales revenues less "Variable" Costs - "variable" being defined according to the marginal costing philosophy.)
Investment (I) is the money tied up in the system. This is money associated with inventory, machinery, buildings, and other assets and liabilities. In earlier Theory of Constraints (TOC) documentation, the "I" was interchanged between "inventory" and "investment." The preferred term is now only "Investment". Note that TOC recommends (I) Inventory be valued strictly on Totally Variable Cost (TVC) associated with creating the (I) Inventory, not with additional cost allocations from overhead.
Operating expense (OE) is the money the system spends in generating "goal units." For physical products, OE is all expenses except the cost of the raw materials. OE includes maintenance, utilities, rent, taxes and payroll.
Organizations that wish to increase their attainment of The Goal should therefore require managers to test proposed decisions against three questions. Will the proposed change:
- Increase Throughput? (T)
- Reduce Investment (inventory) (I)?
- Reduce Operating Expense (OE)?
The answers to these questions determine the effect of proposed changes on system wide measurements:
- Net Profit (NP) = Throughput - Operating Expense = T-OE
- Return on Investment (ROI) = Net Profit / Investment = NP/I
- TA Productivity = Throughput / Operating Expense = T/OE
- Investment Turns (IT) = Throughput / Investment = T/I
Throughput Accounting is an important development in modern accounting that allows managers to understand the contribution of constrained resources to the overall profitability of the enterprise.
Find out how (TA) Throughput Accounting can help your organization: