Theory of Constraints Throughput Accounting Basics

[@mohitsingha210]

Eye-opening. Left stunned. I Gotta do something for my clients....

[@TOCexpert]

Yes, looking at your business using Throughput Accounting can have a profound impact!

[@anildosi3574]

Dear Dr. Lisa / Beau, I have gone through presentation . I have a doubt which I could not get clarified though have given deep thought. Please see segment of video at 34:12 minutes and explain me where from (200,000),(200,000) and (400,000), (500.000) arrived? In both the companies how it is different? Your explanation shall be a great help to me.

[@TOCexpert]

Anil, Please listen to my explanation at 35:09 for additional information on your question; it is answered there. The companies both had total Operating Expenses of $400,000 and $500,000 in Years 1 and 2, respectively. That’s where the (400,000) and (500,000) come from on TA, Inc.’s books because it is using Throughput Accounting and reporting the complete Operating Expense (i.e. no allocations); it’s simply the sum total of payroll, rent, utilities, insurance, etc. necessary to operate the business. The reason that the company, Inventories-R-Us, shows a different amount is that it has done allocations of the Operating Expense. In Year 1, Inventories-R-Us allocated $50,000 to the Cost of Sales and $150,000 to the balance sheet. So, it’s $200,000 of SG&A plus the $50,000 in Cost of Sales and the $150,000 allocated to inventory on the balance sheet adds up to the same $400,000 that is the actual operating expense of the company (this is what Throughput Accounting actually shows, as reported by TA, Inc.). Use the same process to identify the where the costs from Year 2 were placed on Inventories-R-Us’ books. Thus the (200,000) and (200,000) you are inquiring about come from the actual Operating Expense of the company ($400,000 in Year 1, $500,000 in Year 2) affected by the cost allocation process. In the example, it reduced the reported SG&A of Inventories-R-Us as it is growing its inventories, thus pulling more and more costs onto the balance sheet each year. To you second question, how is it different? Well, one set of statements (those for TA, Inc.) show you 1) the actual performance of the company (i.e. Net Profit), 2) the actual breakeven point of the company, and 3) the true financial position of the company via the balance sheet. The other reports are distorted and do not accurately reflect the performance, nor the financial position of Inventories-R-Us. The TA is right, the GAAP/IFRS/cost accounting methodology used by Inventories-R-Us provided distorted figures (incorrect in my view). Thanks, Beau

[@anildosi3574]

@@TOCexpert Thanks for your quick and such a convincing reply dear Beau.

[@TonyBill-iw5rb]

Really great stuff! Would you say that Throughput Accounting is applicable in a non-profit organization, where revenue isn't the goal of the organization?

[@TOCexpert]

Absolutely!

[@TonyBill-iw5rb]

@@TOCexpert do you think you'd be able to help me figure out what throughput would be in my organization?

[@TOCexpert]

@@TonyBill-iw5rb Throughput Accounting would still apply to the $. As far defining your goal in terms of what T is for you, that would be essential for you to figure out.

[@joeypuvel1228]

Try to figure out what would be considered “truly or totally variable” for each unit of service or product you provide. What cost is directly a 1 to 1 basis with each “unit” you provide to your customers?

[@patf4274]

Hi Beau and Lisa, Great job on the presentation! I had a question that I was trying to work out though. In the Buy vs Make slide (around 57 minute mark) how is the Labor accounted for in the Make scenario? I think the immediate pushback that I would get is that the Buy calculation is incorporating the Labor costs and the Make calculation seems to totally ignore it, so it wouldn't be a fair comparison. I'm sure I am missing something obvious. But I'd like to be able to counter that argument since I am a proponent of TA and see the benefits. Any feedback would be appreciated, Thank you!

[@TOCexpert]

Hi Pat, In Throughput Accounting, labor is accounted for in Operating Expense. In the Make Scenario, to produce the item it’s not necessary to hire another worker, thus Operating Expense is the same (and thus shows no change on the slide). We utilize what we call, “The Number”, which has built into it all the Operating Expense a company needs to earn. That would be where and how we ensure that we’re generating enough Throughput-margin to ensure we’re profitable. Thanks!

[@patf4274]

@@TOCexpert Ah, yes I think I see it now. The slide was showing the COGS under the cost accounting method for 'Make' which allocated a portion of labor. By moving that labor cost down to Opex, you can get a true feel for the variable cost and impact on Throughput for each incremental unit. Does that sound about right? Thanks again

[@TOCexpert]

@@patf4274 Yes, that is correct. Throughput-margin, as we call it, is a “clean” number with no distortions. It also creates clarity because there are no allocations to argue about. Everything is relatively straightforward and can be agreed to a vendor invoice or a contact (e.g. sales commissions, royalties, etc.). Thanks!

[@patf4274]

@@TOCexpert Thanks, really appreciate the feedback!

[@funwitharobot]

Under the Make Vs. Buy, if additional labor or another piece of equipment has to be acquired in order to make the parts. Would this cost be added to the Macro OE of the company or would it be a direct input into the cost to make this particular part?

[@mohitsingha210]

Does this mean that valuations of companies are greatly distorted? That stock prices really represent distortion, and the higher the distortion the greater the stock price... please do reply.

[@TOCexpert]

Hi Mohit, Unless we unwind the allocations buried inside companies’ financial statements I contend that an accurate valuation cannot be produced. Now, as to whether or not any single company is over/under or appropriately valued at this time would depend on the unwinding of the allocations in their specific financials. It’s also my position that cost accounting so distorts financials as to not allow comparability between companies in the same industry. In essence, cost accounting causes the financials to act like a “black box” into which investors have little to no insight about. This, in addition to incenting management (when compensation is tied to the stock price) to take actions which negatively affect the company yet report “positive” financial results. Excellent question.

[@arbitram]

I have a couple of questions. the Slide at 57:14 shows Delta OE to be 0 for Make and Buy. That is simplistic right? If I am only buying vs Making the Delta OE should be Negative for Buying right? Another unrelated question: When the product is produced and it is to shipped to a Warehouse in a truck, should the shipment cost be considered OE or Direct Cost and if Direct how should the apportionment happen across products in that Truck? Same with say Power Cost, should it be considered as Variable or OE, if Variable then how should the apportionment happen?

[@TOCexpert]

If I am only buying vs Making the Delta OE should be Negative for Buying right? No, if you're buying then OE would be 0 but TVCs would increase due the purchased part.

[@TOCexpert]

When the product is produced and it is to shipped to a Warehouse in a truck, should the shipment cost be considered OE or Direct Cost? It depends on the situation but given your description most likely it would be a OE. For detailed information check our Throughput Accounting courses at www.theoryofconstraintscpe.com/.

[@bertcruz2774]

Where can I find the 101 series you created? I am seeking to understand and learn more about the applicability of throughput accounting and value it creates by eliminating distortions.

[@TOCexpert]

www.scienceofbusiness.com/throughput-accounting/ and you also may be interested in some of our online throughput accounting courses www.theoryofconstraintscpe.com/pages/throughput-accounting