Throughput Accounting (TA) comes from the same stable of business thinking as the Theory of Constraints TOC (see Theory of Constraints) and is a different way of accounting for a businesses success. It is a major rethink on how to position your business for success. Blue Belt
It shines a different light onto such things as where to best invest your capital when you have several options to consider.
The definitions in TA are:
- Sales: It differs from conventional accounting in that a sale is only counted when you have the cash in hand from the purchaser. This overcomes the distorting effects of produced goods inventory and accounts receivable. Under traditional accounting, these are assets but the company can go broke waiting for payment for them.
- Total Variable Costs (TVC) of production are those that go into the production of your product and which would truly not occur if the product was not produced. For this reason, Salaried Labour (labour that would not disappear if production stopped or slowed) is treated as Overhead Expense as it is not easily eliminated.
- Throughput is Sales-TVC and is the money you have actually cleared from a sale.
- Overhead Expenses (OE) are all expenses that are permanent or close to it and do not fluctuate with production volumes.
- Net Profit is Throughput less OE.
- Investment is all the capital, cash, buildings and inventory tied up in the business. Note that inventory is factored in as an investment cost because it ties up capital. This tends to shine a light on inventory as something that diminishes Return on Investment. Traditional accounting calls it an asset and doesn't shine a light on inventory's impact on ROI.
- Return on Investment (ROI) is NP/I
Under TA, if you have significant surplus capacity in the production system and can find a way to use it, it can make quite a dramatic impact on your bottom line because the cost of any machinery is accounted for under Investment and Salaried Labour is already covered under Overhead Costs so Net Profit goes up as Throughput rises but Operating Expenses and Investment remain unchanged so ROI goes up quite a bit. With traditional accounting, there is no real focus brought to bear on productively using surplus capacity so it might go unnoticed. As you optimize your business, you will probably throw up surplus capacity so using it productively is a good and wise choice.
Throughput Accounting and "Normal" Accounting
This graphic shows the relationships between Throughput Accounting and the more "normal" accounting you may be used to.
Later material to come will show a different approach to capital allocation.