Throughput Accounting – An Introduction

Introduction

Throughput accounting is a method of management accounting which uses Dr Eli Goldratt’s Theory of Constraints to provide useful information to managers for making decisions that facilitate the profitability of the organization. Throughput Accounting looks to transform the way an organization evaluates revenue recognition, costs and profitability and therefore changes the figures used for decision making. In other words, throughput accounting looks to transform management accounting. It does not consider the rules of conventional accounting, particularly, the reliance on efficiencies.

The concepts of throughput accounting

The basic idea behind Eli Goldratt’s theory is the fact that all firms have a set of defined goals and also that improved decision making leads to increase in the organization’s value. This type of accounting also considers bottlenecks (or constraints) that may hamper the process of manufacturing and servicing. According to the Theory of Constraints, there are three measures that are used in decision making. Let’s take a look at each one of these measures in detail:

Throughput: The amount of material processed by an organization is generally the money that is generated from the sale of products. This means the total sales value after subtracting the Truly Variable Cost (TVC) which is the cost of the raw materials used. Throughput also takes into account the time factor; so once the units that can be produced per hour or per day is determined, the throughput of each product can be calculated. For example, a wooden table selling for $50 and comprising of wood and other raw materials worth $10 will give a contribution of $40 per unit. If 20 wooden tables can be manufactured for confirmed sale per hour, then the throughput rate is $800 per hour. Finished goods that are lying in storage are not taken into account for calculating throughput because they have not yet generated sales money. Labor costs are also not subtracted while calculating the throughput.

Investment: Investment refers to all the money that is involved in the system. Investment takes into account the raw materials, finished and unfinished goods, premises, machinery and all other company assets and liabilities.

Operating Expense: Operating expense can be defined as all the money that is spent in converting investment into throughput. The operating expense also takes into account the money spent on labor.

Once the correct values for Throughput, Investment and Operating Expense have been calculated, these can be used by the organization to predict the effect of the management’s decisions with precision.

For example,

Profit = Throughput – Operating Expense, Return on Investment = Throughput -Operating Expense/Investment, Productivity = Throughput/Operating Expense and Cash Flow = Throughput – Investment – Operating Expense.

Conclusion

The measures used by this type of accounting ensures that all management decisions focus on the core target of the company which is to increase profitability.

Sam Greeves writes on subjects that interests him and likes to share information in general like operations management, management accounting , microeconomics etc.

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