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What is the primary goal of your company?
How can an historic Profit and Loss report help you predict the full effect of decisions you need to make today?
Conventional accounting systems focus on measurements such as Net Profit, ROI and Cash Flow. These are all well and good for financial reporting – but they only allow you to see the results of your decisions in retrospect.
To run a business effectively, you need to be able to judge their immediate and future impact!
TOC Throughput Accounting utilizes Dr Goldratt’s groundbreaking measurements of Throughput, Inventory and Operating Expense. These measures can be applied universally across the company and are easily understood by management and those at the cutting edge of shop floor decision making. The process for doing this is known as the TIE Rule.
The TIE Rule:
The TIE Rule says that any decision that increases Throughput more than Inventory and Operating Expense is a good one. It’s that simple.
There are two reasons why Throughput Accounting including the TIE Rule is superior to traditional Cost Accounting.
Firstly, fixed expenses are not made variable. Throughput Accounting does not fall into the Cost Accounting trap of mixing up fixed and variable costs which misstates impact of costs when considering production volume based decisions.
Secondly, Throughput Accounting recognises the existence of the system constraint, whether it be internal to the business or external and in the market. Understanding the location of the constraint is fundamental to developing good strategy, enabling focus and making good decisions.
Throughput (T): The rate at which the system generates money through sales less any direct variable costs associated with those sales. Direct variable costs are typically raw materials, outwork and sales commissions.
Inventory (I): All the money that is tied up in the system.
This can be broken down into two areas:
1. The obvious inventory of raw materials, WIP and finished goods.
2. Investments – i.e. that which is owned by the company in order to generate Throughput – e.g premises, machinery, fixtures and fittings etc.
Operating Expense (OE or E): All the money the system spends in order to convert Inventory into Throughput. This includes all regular labour expenses.
Once the correct figures for T, I and OE have been calculated, the measurements can be used throughout the company to accurately predict the global effect decisions on profit. For example, Profit = T-OE, Return on Investment = T-OE/I, Productivity = T/OE and Cash Flow = T-I-OE.
Our Implementation Approach: