Throughput Accounting
Today, companies are focused on increasing throughput – the rate at which
a company generates money through sales. They want to expand products,
customer base, markets, and so on. They want to grow as much as possible, as
quickly as possible. They do not want to focus on shrinking their company or
labor force. Yet, the most commonly used financial tools tell companies to
focus on cutting costs in order to maximize profits, making expenses the
focus of companies, not sales generation. This often leads management to
make decisions that actually harm a company.
Companies need to use financial tools that move them toward their goal.
Throughput Accounting provides managers with a transparent and focused method to
make decisions that consistently lead them in the right direction. Through
better managerial decision making, Throughput Accounting improves a company’s
ability to make more money now and in the future because it approaches
accounting from a cash management basis. It meets the need that companies have
to meet management challenges, including outsourcing products, process
improvement, and purchasing capital equipment.
The Decision Maker’s Dilemma
It is often difficult to see how decisions made in a local area affect the organization as a whole. This is particularly true of managers who are not able to see or affect every area of the organization. The organizational view of most managers is typically limited to their own area of responsibility and those nearby.
For a business leader in an enterprise, the issue is more troublesome, because he or she must concern themselves with the decision making of multiple managers involved in many aspects of the enterprise. We know from experience that local managers often make decisions that are counter to the purpose of the enterprise. A single person periodically making a bad decision is usually not significant, but if there is a systemic error in many managers’ understanding of the enterprise’s functioning, many poor decisions will be made, which could create significant, long lasting damage.
Larger, subdivided enterprises lose their system-wide perspective, and managers are forced to rely on decision rules that are typically based on Traditional Cost Accounting; the bigger the enterprise, the bigger the problem.
The decision maker is often forced to choose between decisions that make intuitive sense, but must be justified using Traditional Cost Accounting methods.
The Decision Maker’s Challenge
Managers and system owners must find a way to predict and accurately measure the effect of local decisions on the global goal. The challenge is to get local managers to think like business people and make good decisions based on the global system measurements.
- Revenues
- Expenses
- Profit
- Return on investment
Often, in an effort to manage the dollars in an organization, the local managers manage budgets, which, while important, do not mimic the decisions of the business. Most importantly, budget management assumes a fixed revenue source, over which local managers have no control. The result is that local management decisions become one dimensional – based on expenses and local optimization. The reality is that every local manager, being part of the system, can have a significant impact on the revenues of an enterprise. Every manager should be using the same methods to evaluate the quality of their decisions; based on the impact on net profit and return on investment (short and long term).
Throughput Accounting Bridges the Gap
Throughput Accounting focuses on increasing revenue (throughput),
improving cash flow (investment) and providing capacity (operating expense).
Every management decision is made based on expected changes in throughput,
investment and operating expense. Throughput Accounting allows managers to
take a more balanced approach to decision making, giving an accurate picture
of the results of decisions. Throughput Accounting also demonstrates
ways to make more profitable pricing and marketing decisions.
Throughput Accounting shifts the emphasis in decision making from managing
costs and budgets to maximizing throughput and profitability. It
emphasizes the improvement of flow through the system, providing feedback on the
financial impact of the constraint. It drives management decisions
to improve the constraint’s efficiency; ensuring all company resources support
the constraint, so that profit can be maximized.
This approach differs substantially from Traditional Cost Accounting because
the company is not focused on every machine and employee working at optimal
efficiency. Instead, its basis is that if a company optimizes any
non-constraint, it will overload the constraint and create excess inventory.
Throughput Accounting provides a way to measure productivity improvement
efforts based on how they affect cost and throughput. It can be applied to
decisions that affect all aspects of a company including product price, process
improvement, reward structures, investment justification, transfer pricing, and
performance management. The result is a thorough understanding of how a company
is functioning as a whole and the ability to analyze the true impact of
management decisions before they are made.