Since long organisations have been focussing largely on Cost reductions to improve their bottomline. Contrary to this belief, the world of Theory of Constraints believes in “Throughput Accounting”. It is a simplified method which enables the entire organisations right from the people assigned with day to day tasks to the top management. It focusses more on increasing Sales, reducing the “Truly Variable Cost” i.e. COGS. & increasing profitability.

Throughput becomes the prime indicator of the organisations decision making process & the growth.

Key measurements:

Throughput (T)

Throughput, is the rate at which organisation makes money.

Throughput = Sales – Truly Variable Cost

Truly variable cost is the cost which is incurred in direct proportion to sales.

Operating Expenses (OE)

Operating Expenses are all expenses, except the Truly variable costs, incurred to manage the company. Operating Expenses are largely fixed with few exceptions.

Investments (I)

Investments, is the money which is tied-up in the system which gets converted into Throughput. This can be in the form of raw materials waiting to be transformed into sellable products as well as investments in machineries / equipments to produce more units.

Net Profit (NP)

Net Profit is defined as Throughput minus Operating Expenses, or

 Sales – Truly Variable Costs – Operating Expenses.

NP = T – OE

Return On Investment (ROI)

Return On Investment is the Net Profit compared to Investments

ROI = NP/I.

Productivity (P)

Productivity  = Throughout / Operating Expenses

P = T/OE

Investment Turns

Investment Turns = Throughout / Investment

IT = T/I

Drivers for achieving the Goal

Throughput Accounting offers a simplified way to identify and use the drivers to achieve the Goal, assuming the Goal is to make money now and in the future.

In a very simple way this can be summarized by the following picture which means strive to maximize Throughput while minimize the Operating Expenses and Investments.

An organisations pursuit should be to maximise Thoughput (focusing on the constraint exploitation)

Throughput Analysis

Beyond the simplification compared to traditional accounting, Throughput Accounting sets the base for Throughput Analysis, helping to make decisions in the ToC way.

Food for Thought: In a system with a capacity constraint, the Throughput is limited and controlled by the constraint. When available capacity if fully utilised and no spare capacity is available to exploit, what goes through the constraint must be chosen wisely in order to make the utmost use of this constraint.

The higher the exploitation of this constraint will result in higher Throughput for the organisation.

Focussing on Throughput will help organisations to generate substantial profits & drive the decision making ability of each individual in the organisation.

The illustration placed below will provide an insight on how increasing sales & Throughput can maximise the profitability of the company, provided there is a control on the OE.