Throughput accounting
outline
Theory of constraints
Throughput accounting
Performance measures in throughput accounting
Throughput accounting ratio
Theory of constraints
The theory of constraints (TOC) is an approach to
production management and optimising production
performance. It was formulated by Goldratt and Cox in
the US in 1986. Its key financial concept is to turn
materials into sales as quickly as possible, thereby
maximising the net cash generated from sales.
Throughput = Sales – Material costs
Bottleneck factor: the constraint
Time available
Limited selling resource
Lack of quality
Lack of reliable suppliers
Lack of skilled employees
Lack of machinery
Basic assumptions underlying throughput
accounting
Since there is one bottleneck resource all other sources are not
bottlenecks
Idle time should be accepted. Since all operational costs are fixed, idle
time is not costing any money.
Non-bottleneck resources should not be used beyond amount
required to achieve max output. As it is considered wasteful
No inventory should be built up except buffer inventory.( because
inventory cost you money in terms of space and Throughput
discouraged this.
Except material all costs are fixed
Increasing throughput: elevating the
bottleneck
The only way to increase throughput is to increase the
capacity of the bottleneck constraint
For example, time on Machine Type X may be a
bottleneck resource.
Moving from working five days a week to working six
or seven days a week
Moving from working a 12-hour production day to an
18-hour or 24-hour
five-step approach
1. Identify the constraint (bottleneck resource).
2. Decide how to exploit the constraint in order to
maximise throughput.
3. Subordinate and synchronise everything else to the
decisions made in step 2.
4. Elevate the performance of the constraint.
5. If the constraint has shifted during any of the above
steps, go back to step 1
Throughput accounting (TA)
Throughput accounting (TA) is an approach to
production management which aims to maximise sales
revenue less materials cost, while also reducing
inventory and operational expenses.
Throughput accounting concepts
Throughput accounting is based on the following
concepts, all derived from the TOC
1. In the short run, all costs in the factory (with the
exception of materials costs) are fixed costs.
2. In a JIT environment, all inventory is a 'bad thing' and the
ideal inventory level is zero. Products should not be
made unless a customer has ordered them
3. Profitability is determined by the rate at which 'money
comes in at the door' (that is, sales are made) and, in a JIT
environment, this depends on how quickly goods can be
produced to satisfy customer orders.
Difference
Conventional cost accounting Throughput accounting
Inventory is an asset. Inventory is not an asset.
Costs can be classified either as direct or No such classfication
indirect.
Direct labor is a variable cost. Except material all are fixed cost
Profit can be increased by reducing cost Profit is a function of material cost,
elements. total factory cost and throughput. Profit
= throughput minus TFC.
Performance measures in
throughput accounting
Performance measures in throughput accounting are
based around the concept that the aim is to maximise
throughput. This is achieved by maximising the
throughput per unit of bottleneck resource.
When an organisation makes more than one product,
total throughput is maximised by giving priority to
those products that earn the largest throughput per
unit of bottleneck resource. Products should be
ranked in order of priority according to their
throughput per unit of bottleneck resource.
The ratio for ranking products is therefore as follows.
Throughput return per factory hour:
Sales direct material costs
Usage of bottleneck resource in hours (factory hours)
Example:
WR Co manufactures three products, A, B and C.
Product details are as follows.
Product A Product B Product C
Sales 2.8 1.6 2.4
Material cost 1.2 0.6 1.2
Direct lab 1 0.8 0.8
cost
Weekly sales 4000 units 4000 units 5000 units
demand
Machine 0.5 hours 0.2 hours 0.3 hours
hours per
unit
Machine time is a bottleneck resource and maximum
capacity is 4,000 machine hours per week. Operating
costs including direct labour costs are $10,880 per
week
Direct labour workers are not paid overtime and work
a standard 38-hour week
Required???
Determine the optimum production plan for WR Co
and calculate the weekly profit that would arise from the
plan.
Solution
A B C
SP 2.8 1.6 2.4
Mater cost 1.2 0.6 1.2
Throughput 1.6 1 1.2
per unit
Machine hrs 0.5 0.2 0.3
per unit
Throughput $3.2 $5 $4
per machine
hour(w1)
Rank 3rd 1st 2nd
Optimal production plan
Product Units Bottleneck Total hrs Throughpu Total
hrs t per hour throughpu
$ t
$
B 4000 0.2 800 5 4000
C 5000 0.3 1500 4 6000
2300
A(balance) 3400 0.5 1700 3.2 5440
4000 15440
Less (10880)
operating
expenses
profit 4560
Throughput accounting ratio
The throughput accounting ratio (TA ratio) is the ratio of the
throughput per unit of bottleneck resource to the factory cost per unit
of bottleneck resource. This ratio should be as high as possible, and
certainly more than 1.0.
Formula=
Throughput per unit of bottleneck resource
Factory cost per unit of bottleneck resource
Where Factory cost per unit of bottleneck resource =
Total factory costs
Total units of bottleneck resource
Note. 'Total factory costs' are also described as 'Total operating costs'.
They are all the costs other than material costs, and are regarded as a
fixed cost per period.
example
Selling price=160
Material cost=20
Machine hrs per unit= 2
Machine x limited output capacity=500 per week
Operating cost $30000 per week
requirement?
Calculate TA(Throughput accounting ratio)
Solution
Throughput per machine hr= (160-20)/2=70
Factory cost per machine hr=$30000/500hrs=60
TA ratio= $70/$60=1.17
A TA ratio that is not much higher than 1.0 is barely
profitable.
Interpretation
Total throughput should exceed total factory costs
otherwise the organisation will make a loss. This
means that the TA ratio should exceed 1.0.
(Higher TA ratios should be given priority over lower
TA ratios).
Question
Corrie Company produces three products, X, Y and Z. The capacity of Corrie's
plant is restricted by process Alpha. Process Alpha is expected to be operational
for eight hours per day and can produce 1,200 units of X per hour, 1,500 units of
Y per hour and 600 units of Z per hour.
Product Selling price Material Throughput
per unit cost per per unit
unit
X 150 80 70
Y 130 40 90
Z 300 100 200
Operating costs are $720000 per day
Requirement
(a) Calculate the profit per day if daily output achieved
is 6,000 units of X, 4,500 units of Y and 1,200 units of
Z.
(b) Calculate the TA ratio for each product.
Solution (a)
Product Throughput Output achieved Profit per day
contribution
X $70 6000 420000
Y $90 4500 405000
Z $200 1200 240000
total $1065000
Operating costs ($720000)
$345000
Solution (b)
TA ratio = Throughput per factory hour/Operating costs
per factory hour
Operating costs per factory hour = $720,000/8 = $90,000
Product Throughput per Operating cost TA ratio
factory hour per hour
X $70*1200=$84000 $90000 0.93
Y $90*1500=135000 $90000 1.5
Z $200*600=120000 $90000 1.33
Question
Growler manufactures computer components. Health and safety
regulations mean that one of its processes can only be operated eight
hours a day. The hourly capacity of this process is 500 units per hour.
The selling price of each component is $100 and the unit material cost
is $40. The daily total of all factory costs (conversion costs) is $144,000,
excluding materials. Expected production is 3,600 units per day.
Required
Calculate:
(a) Total profit per day
(b) Return per factory hour
(c) Throughput accounting ratio
solution
Total profit per day = Throughput contribution – Conversion costs =
(3,600 × (100 – 40) – 144,000) = $72,000
Return per factory hour =
Sales – direct material costs
Usage of bottleneck resource in hours (factory hours)
=100-40
1/500
Throughput accounting ratio =
Re turn per factory hour
Total conversion cost per factory hour
30000
144000/8
1.67
How can a business improve a throughput
accounting ratio?
Increase sales price per unit
Reduce material costs per unit,
Reduce operating expenses
Improve efficiency, and increase the number of units
or product
Elevate the bottleneck, so that there are more hours
available of the bottleneck resource.
