What is Throughput Accounting?
Throughput Accounting was developed by Dr. Eliyahu Goldratt in his bestselling book, “The Goal.”
If you have not already read “The Goal,” go pick up a copy today. Or even better, pick up both a copy of the book and an audio book version to listen to on the go. Because it is a business novel, it’s a really pleasant read and listen.
Why You Have Not Heard of Throughput Accounting?
You have not heard of Throughput Accounting for two reasons:
- The Theory of Constraints (TOC) and Throughput Accounting was introduced in a bestselling novel and not a $180 textbook.
- TOC and Throughput Accounting is simple and simple does not provoke academic research. If there is no academic research, there is little chance of incorporation into university curriculum. If it is not incorporated into university curriculum, especially accounting curriculum, your CPA or accountant has not even had a chance of hearing about it.
How Simple is Throughput Accounting?
Throughput Accounting comprises of three categories:
- Throughput (T): Sales Price less Cost of Materials.
- Inventory/Investment (I): Inventory (only consisting of material costs) & fixed assets. For the remainder of this article, I’ll refer to this as Investment.
- Operating Expense (OE): Everything else.
So, pretty simple!
However, before any CPA and Accounting nerds get upset, Throughput Accounting is not meant to replace Generally Accepted Accounting Principles (GAAP).
Throughput Accounting is used for internal management purposes and replaces traditional Cost Accounting. All the managerial accountant nerds can now get upset.
How is Throughput Accounting Used?
All business decisions are evaluated using the following Throughput Accounting Premise:
Will this business decision increase Throughput while simultaneously reducing Investment and Operating Expense?
While the business decision may increase Investment or Operating Expense, if the increase in Throughput generally exceeds any increase in Investment or Operating Expense, the business decision can be worthwhile.
However, the goal is to increase Throughput while simultaneously reducing Investment and Operating Expense… A win-win decision; NOT a compromise.
Is Throughput Accounting New?
Yes and No…
Let’s start with the “No” first.
“No” because if you were to open just about any intermediate textbook on microeconomics or management science, you will encounter two fundamental points.
- The only relevant costs are variable costs.
- Profit (revenue minus variable costs) is maximized.
While, as stated, these two items are extremely simplified, they are indeed equivalent to Throughput.
So why is Throughput Accounting new?
What Dr. Goldratt does differently is that he takes this vary basic and axiomatic economic concept and shows that these simple fundamental concepts work. At the same time, he shows that the complex “sacred cows” generally taught in MBA and Accounting programs generally make things worse.
Why Does Throughput Accounting Work?
It is simple… While a simple solution is not always the best solution, the best solution is often the simple solution.
Through simplification, a business can achieve laser sharp focus on the goal of being in business: To Make Money.
Money is made by increasing Throughput while simultaneously reducing Investment and Operating Expense.
Throughput, theoretically, has no hard upper bound. Increasing Throughput increases profitability. The potential for unlimited increases in Throughput, and profits, makes Throughput the organization’s top priority.
Investment is money “caught” within the business. Reducing Investment reduces Operating Expenses (carrying costs), frees up cash, and increases Return on Investment (ROI).
Reducing Operating Expense is not a long-term strategy to business success and reducing Operating Expense, on its own, is NEVER the goal. The reason for this is mathematical. Operating Expense can only be reduced theoretically to zero. Also, Operating Expense reduction beyond the minimum operating threshold can reduce Throughput which is the opposite of the goal.
We can see that an increase in Throughput along with a simultaneous decrease in Operating Expense and Investment results in the greatest increase in ROI.
Throughput Accounting Is Commonsense!
Throughput Accounting is a commonsense approach to management accounting designed to focus management’s decisions on the primary goal of business: to make money.
Unfortunately, commonsense is often overlooked by those who prefer building overly complex academic solutions that do very little to improve businesses. Simple and useful is not the focus of PhD programs!
If you found this brief introduction to Throughput Accounting interesting and would like to learn more, I highly recommend reading “The Goal”:
The Goal, by Eliyahu M. Goldratt and Jeff Cox.
I consider it a must read for all business owners.
Feel free to leave a comment below regarding your thoughts on Throughput Accounting, the Theory of Constraints, or “The Goal.”