THROUGHPUT ACCOUNTING.

• THROUGHPUT ACCOUNTING HAS DEVELOPED IN RESPONSE TO JIT

THEORY AND IT USES THE THEORY OF CONSTRAINTS.
• AN OBJECTIVE FOR AN ORGANISATION IS TO MAXIMISE THROUGHPUT BY
IDENTIFYING AND ELIMINATING BOTTLENECKS.
• THROUGHPUT ACCOUNTING IS A PRODUCT MANAGEMENT SYSTEM
WHICH AIMS TO MAXIMISE THROUGHPUT, AND THEREFORE CASH
GENERATION FROM SALES, RATHER THAN PROFIT.
• A JIT ENVIRONMENT IS OPERATED WITH BUFFER INVENTORY KEPT ONLY
WHEN THERE IS A BOTTLENECK RESOURCE
• THE THEORY OF CONSTRAINTS IS (TOC) IS AN APPROACH TO
PRODUCTION MANAGEMENT WHOSE KEY FINANCIAL CONCEPT IS TO
TURN MATERIALS INTO SALES AS QUICKLY AS POSSIBLE THEREBY
MAXIMISING THE NET CASH GENERATED FROM SALES
• THIS IS ACHIEVED BY STRIVING FOR A BALANCE IN PRODUCTION
PROCESSES, AND SO EVENNESS OF PRODUCTION FLOW IS ALSO AN
IMPORTANT AIM.
• THE THEORY OF CONSTARINTS IS AN APPROACH TO PRODUCTION
MANAGEMENT WHICH AIMS TO MAXIMISE SALES REVENUE LESS
MATERIAL COSTS AND VARIABLE OVERHEAD COST.
• IT FOCUSES ON FACTORS SUCH AS BOTTLENECKS WHICH ACT AS
CONSTRAINTS TO THIS MAXIMISATION
• A BOTTLENECK OR BINDING CONSTRAINT IS AN ACTIVITY WHICH HAS A
LOWER CAPACITY THAN THE PRECEDING OR SUBSEQUENT ACTIVITIES,
THEREBY LIMITING THROUGHPUT
• ONE PROCESS WILL INEVITABLY ACT AS A BOTTLENECK (OR LIMITING
FACTOR) AND CONSTRAIN THROUGHPUT. THIS IS KNOWN AS A BINDING
CONSTRAINT
• STEPS MUST BE TAKEN TO REMOVE THIS CONSTRAINT BY BUYING MORE
EQUIPMENT OR IMPROVING PRODUCTION FLOW
• BUT ULTIMATELY THERE WILL ALWAYS BE A BINDING CONSTRAINT
UNLESS CAPACITY IS FAR GREATER THAN SALES DEMAND OR ALL
PROCESES ARE TOTALLY IN BALANCE WHICH IS UNLIKELY.
 • OUTPUT THROUGH THE BINDING CONSTRAINT SHOULD NEVER BE
DELAYED OR HELD UP OTHERWISE SALES WILL BE LOST
• TO AVOID THIS A BUFFER INVENTORY SHOULD BE BUILT UP IMMEDIATELY
PRIOR TO THE BOTTLENECK
• THIS IS THE ONLY INVENTORY THAT THE FIRM SHOULD HOLD WITH THE
EXCEPTION OF POSSIBLY A VERY SMALL AMOUNT OF FINISHED GOODS
INVENTORY AND RAW MATERIALS THAT ARE CONSISTENT WITH THE JIT
APPROACH.
• OPERATIONS PRIO TO THE BINDING CONSTRAINT SHOULD OPERATE AT
THE SAME SPEED AS THE BINDING CONSTRAINT TO AVOID WIP BUIDLING
UP
• INVENTORY COSTS MONEY IN TERMS OF STORAGE SPACE, INSURANCE,
INTEREST COSTS AND THEREFORE INVENTORY IS NOT DESIRABLE
• THE OVERALL AIM OF TOC IS TO MAXIMISE THROUGHPUT CONTRIBUTION
( SALES REVENUE MINUS MATERIAL COST) WHILE KEEPING CONVERSION
COST AND INVENTORY COSTS TO THE MINIMUM.
• A STRATEGY FOR INCREASING THROUGHPUT CONTRIBUTION WILL ONLY
BE ACCEPTED IF CONVERSION AND INVESTMENT COSTS INCREASE BY A
LOWER AMOUNT THAN THE INCREASE IN CONTRIBUTION.
EXAMPLE:
MACHINE X CAN PROCESS 1000 KGS OF RAW MATERIAL PER HOUR, AND
MACHINE Y 800 KGS. OF AN INPUT OF 900 KGS, 100 KGS OF PROCESSED
MATERIAL MUST WAIT ON THE BOTTLENECK MACHINE (Y) AT THE END OF AN
HOUR OF PROCESSING.

Input raw Machine X (can process Machine Y(can

Material 1,000 kgs/hour) process 800kgs/hr
900kgs 900kgs 800kgs

100 kgs
• THE TRADITIONAL VIEW IS THAT MACHINES SHOULD BE WORKING, NOT
SITTING IDLE
• IF THE DESIRED OUTPUT FROM THE PROCESS ABOVE WERE 8100 KGS,
MACHINE X WOULD BE KEPT IN CONTINUAL USE AND ALL THE 8,100 KGS
WOULD BE PROCESSED THROUGH THE MACHINE IN NINE HOURS.
• HOWEVER, THERE WOULD BE A BACKLOG OF 900 KGS [8100 – (9 HRS
*800)] OF PROCESSED MATERIAL IN FRONT OF MACHINE Y.
• ALL THIS MATERIAL WOULD REQUIRE HANDLING AND STORAGE SPACE
AND CREATE THE ADDITIONAL COSTS RELATED TO THESE NON VALUE
ADDED ACTIVITIES
• THE PROCESSING OF THESE WOULD NOT INCREASE THROUGHPUT
CONTRIBUTION.
• THROUGHPUT ACCOUNTING IS AN APPROACH TO ACCOUNTING WHICH IS
LARGELY IN SYMPATHY WITH THE JIT PHILOSOPHY.
• IN ESSENCE IT ASSUMES THAT A MANAGER HAS A GIVEN SET OF
RESOURCES AVAILABLE WHICH COMPRISE OF EXISTING
BUILDINGS,CAPITAL EQUIPMENT AND LABOUR FORCE
• USING THESE RESOURCES, PURCHASED MATERIALS AND PARTS MUST BE
PROCESSED TO GENERATE SALES REVENUE
• GIVEN THIS SCENARIO THE MOST APPROPRIATE FINANCIAL OBJECTIVE TO
SET FOR DOING THIS IS THE MAXIMISATION OF THROUGHPUT WHICH IS
DEFINED AS : SALES REVENUE MINUS DIRECT MATERIAL COST
• THROUGHPUT ACCOUNTING FOR JIT IS BASED ON THREE CONCEPTS:

1. IN THE SHORT RUN, MOST COSTS IN THE FACTORY (EXCEPT MATERIAL

COSTS) ARE FIXED (THE OPPOSITE OF ABC, WHICH ASSUMES THAT ALL
COSTS ARE VARIABLE). THESE COSTS INCLUDE DIRECT LABOUR. IT IS
IMPORTANT TO GROUP ALL THESE COSTS TOGETHER AND CALL THEM
TOTAL FACTORY COSTS (TFC)
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. WHEN GOODS ARE MADE ,
THE FACTORY EFFECTIVELY OPERATES AT THE RATE OF THE SLOWEST
PROCESS AND THERE WILL BE UNAVOIDABLE IDLE CAPACITY IN OTHER
 OPERATIONS. WIP SHOULD BE VALUED AT MATERILA COST ONLY UNTIL
THE OUTPUT IS EVENTUALLY SOLD SO THAT NO VALUE WILL BE ADDED
AND NO PROFIT EARNED UNTIL THE SALE TAKES PLACE. WORKING ON
OUTPUT JUST TO ADD TO WIP OR FG INVENTORY CREATES NO PROFIT
AND SO SHOULD NOT BE ENCOURAGED.
3. PROFITABILITY IS DETERMINED BY THE RATE AT WHICH MONEY COMES IN
AT THE DOOR I.E SLAES ARE MADE, AND IN A JIT ENVIRONMENT THIS
DEPENDS ON HOW QUICKLY GOODS CAAN BE PRODUCED TO SATISFY
CUSTOMER ORDERS. SINCE THE GOAL OF A PROFIT ORENTATED FIRM IS
TO MAKE MONEY, INVENTORY MUST BE SOLD FOR THAT GOAL TO BE
ACHIEVED. BOTTLENECK RESOURCES SLOWS THE PROCESS OF MAKING
MONEY.
• THE AIM OF THE MODERN MANUFACTURING APPROACHES IS TO MATCH
PRODUCTION RESOURCES WITH THE DEMAND FOR THEM WHICH IMPLIES
THAT THERE ARE NO CONSTRAINTS, TERMED BOTTLENECK RESOURCES IN
TA WITHIN AN ORGANISATION
• THE THROUGHPUT PHILOSOPHY ENTAILS THE IDENTIFICATION AND
ELIMINATION OF THESE BOTTLENECK RESOURCES BY OVERTIME,
PRODUCT CHANGES AND PROCESS ALTERATIONS TO REDUCE SET UP AND
WAITING TIMES
• OTHER FACTORS WHICH MIGHT LIMIT THROUGHPUT OTHER THAN A LACK
OF PRODUCTION RESOURCES INCLUDE:
1. THE EXISTENCE OF AN UNCOMPETITIVE SELLING PRICE
2. THE NEED TO DELIVER ON TIME TO PARTICULARR CUSTOMERS
3. THE LACK OF PRODUCT QUALITY AND RELIABILITY
4. THE LACK OF RELIABLE MATERIAL SUPPLIERS
5. THE SHORTAGE OF PRODUCTION RESOURCES.