Using Throughput Accounting for making decisions

Theory of Constraints and Software Engineering

Throughput Accounting (TA) is TOC’s approach to accounting. We also find the first application of TA to the field of Software Engineering. Anderson’s ideas have been further expanded to the professional, scientific, and technical services businesses, and therein to information technology and software engineering.

Throughput Accounting is defined by the following arithmetic expressions:

  • Throughput:
    T = Revenue – Totally Variable Expenses

  • Net Profit:
    NP = Throughput – Operating Expense

  • Return on Investment:
    ROI = Net Profit / Investment

Unfortunately, TA has gained a bad reputation mostly within the circles of accounting professionals, mostly due to the fierce position taken by Goldratt against traditional accounting practices. Besides, the politics, the reputation is undeserved, as we will see. TA can truly be added to the arsenal of management tools, often with spectacular effects on the bottom line.

Originally, it was the need to manage business system in a more scientific way that led to the creation of TA. In fact, TA is defined by a few simple formulas, that might somehow remind of the equations one finds in physics.

With only three variables to consider, TA becomes accessible to and usable by non-accounting professionals. Decision-making is simplified. To make the correct decision, you need a positive answer to one of these three questions:

  • Does it increase throughput?
  • Does it reduce operating expenses?
  • Does it increase the return on investment?

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One Response to Using Throughput Accounting for making decisions

  1. Nelson McEwan says:

    Requiring a positive answer to just one of these 3 questions is simplistic advice, and can “permit” a damaging decision on occasions. An improved question to replace the first 2 is, “Will this action increase {delta T minus delta OE}?”. The 3rd question is simply dangerous. In many circumstances, trying to improve performance by taking actions which enlarge the apparent ROI, will actually cause real damage, rapidly. Examples are deliberate reduction in inventory or assets – to the extent that they transform a necessary condition into a constraint. Worse, the damage will not have been predicted, and will not be apparent until the effects are irreversible. Read John Caspari’s book.

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