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July 2, 2011

A Summary of Throughput Accounting

Throughput Accounting is an approach developed out of the Theory of Constraints approach to process improvement. Throughput Accounting falls under the heading “flow accounting”, along with lean accounting. Both techniques are similar (with some terminology differences) and seek to align costs with the flow through a Value Stream or process.


In Throughput Accounting (and Lean Accounting) the philosophy is that we increase profitability and reduce cost by increasing the rate of flow through the whole process or Value Stream.


Throughput Accounting Definitions:


“Throughput” is defined as Net Sales less Total Variable Cost. Total Variable Cost is usually taken as material cost only, though there may be other truly variable costs in a particular process. “Throughput” is very similar to “Contribution” in cost accounting.


“Investment” is defined as the money tied up in the process or Value Stream – that is the equipment, inventory, facilities, buildings and other assets and liabilities that form part of the Value Stream (or process). Note that Throughput Accounting values inventory strictly on totally variable cost (material cost) only – without labour or overhead.


“Operating Expense” is the other direct costs associated with the Value Stream or process excluding any allocations or external overheads.


“Net Profit” (also called Value Stream Profit) = Throughput less Operating Expense.


Throughput Accounting Ratios


“Return on Investment” is Net Profit divided by Investment, expressed as a percentage. This is a useful measure to compare Value Streams. We can improve a Value Stream’s return on investment by increasing the revenue of the Value Stream; by reducing inventory as we improve flow; and by reducing waste.


“Productivity” is defined as Throughput divided by Operating Expense, expressed as a percentage. This is a reflection of the level of “contribution” in the Value Stream.


“Investment Turns” is defined as Throughput divided by Investment, expressed as a ratio. Any decision that improves this ratio for a Value Stream will inevitably improve the profitability of the Value Stream. Thus the “Investment Turns” measure is a useful first-cut way of ranking alternative decisions.


Throughput Accounting is easy to understand and provides useful tools for understanding and improving flow in a process or Value Stream. Align your cost centres with Value Streams or processes, avoid allocation of corporate overheads, and you are ready to work out the ratios identified to support process improvement.