12.4 Throughput Accounting

While the five focusing steps and the drum-buffer-rope approach equip businesses with strategies to improve, maintain, and control process flow, throughput accounting offers a means to evaluate the effectiveness of these improvements. For organizations contemplating various enhancements, throughput accounting yields metrics that assist in prioritizing such projects, acting as an alternative to traditional cost accounting practices. Its focus rests on sales and the costs that are genuinely variable with production levels.

To illustrate, take the case of an employee earning a wage of $15 per hour. This wage is fixed irrespective of the number of units produced, and hence, in throughput accounting, would not be considered a variable cost. The three fundamental metrics defined by TOC are:

• Throughput (T): This metric represents the rate at which the system generates ‘goal units’, or in financial terms, the rate at which money is entering the system. Calculated as sales (S) minus total variable costs (TVC), throughput only occurs upon the sale of the process output. TVC could include the cost of raw materials and sales commissions, among others.
• Investment (I): Investment encompasses all the money tied up within the system, including both assets and inventories.
• Operating Expense (OE): This is the expenditure the system incurs to create goal units, covering costs such as payroll, maintenance, depreciation, utilities, and taxes, but not the cost of raw materials, as these are part of TVC.

The overarching aim for any business should be to maximize T while minimizing I and OE. TOC thus offers universal metrics for decision-making, encapsulated in the formulas for Net Profit (NP = T – OE) and Return on Investment (ROI = (T – OE)/I), aiding businesses in assessing the value of potential investments and improvements.

Consider a company debating whether to invest in automated robotic systems for non-bottleneck operations. These robots, despite modernizing the production line, would not elevate T, which is constrained by the system’s bottleneck. With an increased I due to the capital invested in robots and an escalated OE over time from higher depreciation costs, the NP and ROI would likely decrease. According to TOC, such an investment should be avoided.

Contrastingly, traditional cost accounting is preoccupied with local costs and efficiencies, which might lead to the high utilization of robots to defray their cost across more units, ostensibly reducing the cost per unit produced. This cost-centric mindset encourages full utilization of all resources. However, throughput accounting challenges this view, holding that the primary business goal is to generate money both now and in the future. It contends that production increases at non-bottlenecks merely inflate WIP without raising final throughput. Consequently, TOC maintains that a non-bottleneck should be considered ‘utilized’ only when aiding the bottleneck in generating throughput. If robots produce items that the bottleneck does not immediately require, they may be active but not effectively utilized, according to throughput accounting principles.