A Process Of On-Going Improvement (POOGI) - Part 14

We are continuing our series based on The Goal by Eliyahu M Goldratt.

Throughput is the rate at which the system generates money. It is similar to Gross Margin or Contribution Margin, but it is also different in that TOC (Theory of Constraints) does not consider direct labor as a variable cost, but rather as Operating Expense.

The role of the company’s constraint is fundamental for quantifying the decision’s impact on the three measurements. Thus, to identify which products contribute the most to the company’s net profit, TOC advocates the use of the measurement of “Throughput per time of the constraint”. This method is much simpler than costing methods. It allows for fast decisions that are directly linked to the bottom line.

Next month we will explore Throughput Accounting in more depth, and explain how implementing its concepts will help you understand the rate at which your company makes money. We will also discuss how Throughput Accounting affects pricing decisions.

If you’d like to be better prepared for the discussion, we recommend one or more of the following books:

• The Haystack Syndrome by Dr. Goldratt,
• The Theory of Constraints and Its Implications for Management Accounting by Noreen, Smith, and Mackay, and
• Throughput Accounting by Corbett.

You can also search this blog for Throughput Accounting.

...to be continued.

Here's to maximizing YOUR profits!

Dr Lisa Lang
(c)Copyright 2008, Dr Lisa, Inc. All rights reserved.

A Process Of On-Going Improvement (POOGI) - Part 13

We are continuing our series based on The Goal by Eliyahu M Goldratt.

The core idea in the Theory of Constraints (TOC) is that every real system, such as a for-profit business, must have at least one constraint. If it were not true, then the system would produce an infinite amount of net profit. Because a constraint is a factor that limits the system from getting more net profit, then a business manager who wants more net profit must manage constraints. The constraints will determine the output of the system whether they are acknowledged and managed or not.

Dr. Goldratt says it this way: “Before we can deal with the improvement of any section of a system, we must first define the system’s global goal; and the measurements that will enable us to judge the impact of any subsystem and any local decision on this global goal”.

It is impossible to disentangle using TOC in operations (DBR) from TOC accounting (known as “Throughput Accounting”). Any attempt to run TOC in operations while using traditional management accounting measures and controls is doomed to failure. TOC is a radically different way to control operations and does not work with conventional cost accounting systems.

As an alternative, TOC and Throughput Accounting introduce three measurements for increasing net profit:
1. increase Throughput (Sales minus truly variable costs such as raw materials),
2. decrease Operating Expenses (that is, fixed costs), or
3. decrease Investment, particularly in inventories.

To make decisions according to TOC, we need to quantify the decision’s impact on these three measurements and then we will be able to determine the change in net profit and return on investment.

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang

(c)Copyright 2008, Dr Lisa, Inc. All rights reserved.

A Process Of On-Going Improvement (POOGI) - Part 12

What is the effect on the monthly Profit and Loss statement from this?

Because cost accounting (and GAAP) requires that inventory absorb allocated costs, the effect is that all of the cost allocations from prior months that are attached to the inventory will be recognized in the month of the inventory reduction, causing a significant “loss” from this change in inventory.

If your management is aware of this, it may block the implementation of DBR in order to avoid the perceived negative impact. If no one blocks the implementation of DBR, the result will be recognized when the P&L is compiled. At that time, management will be “surprised”. So will be the bank and any other outside entity that has interest in your company’s financials.

Efficiency measurements typically evaluate the effectiveness of labor and equipment utilization. The goal is to strive for as high of efficiency as possible for all resources. However, DBR strives to have high utilization on only one resource: the system’s constraint. As a result, all other labor and equipment resources will have lower efficiencies. Again, if management perceives this as a negative outcome, it may block the implementation. Or, if DBR is implemented, when the efficiency reports are generated, management will be “surprised” by the lower efficiencies on most resources. So will anyone else that has interest in your company’s efficiencies.

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang
(c)Copyright 2008, Dr Lisa, Inc. All rights reserved.
_____________________________________________
About the authors:Brad Stillahn is a business owner that has successfully implemented Eliyahu M Goldratt's Theory of Constraints (TOC) methods in his own business and is now helping other business owners do the same. His consulting company, TOC Professionals engages in long-term relationships with companies implementing TOC. His business and personal partner is Dr. Lisa Lang. Brad can be reached at Brad@ScienceofBusiness.com or 303-886-9939.

“Dr. Lisa” Lang is President of the Science of Business. Her speech “Maximizing Profitability” is popular with Vistage groups and as a keynote speech. Recently Dr. Goldratt’s Global Marketing Director, she offers the “Mafia Offer Boot Camp” for companies wanting to develop and implement a Mafia Offer. She can be reached at DrLisa@ScienceofBusiness.com or 303-909-3343.

A Process Of On-Going Improvement (POOGI) - Part 11

Conventional cost accounting assumes that incremental and isolated cost improvements are productive and in support of an organization’s goals, and that global improvement equals the sum of local improvements.

Since a conventional cost accounting system relies on transaction data—each transaction is a separate event—it is incapable of a holistic or systems thinking perspective except when closing the books. In addition, conventional cost accounting is not capable of giving good information because it assumes that all the company’s resources are equally important.

So, how would cost accounting block you from implementing the Drum-Buffer-Rope scheduling methodology? In at least two ways:

• because of the way inventory is valued, and
• because of the impact on efficiency measurements.

Remember from the discussion of Drum-Buffer-Rope last month that we expected a reduction in Work-in-Process inventory to about half of its initial level. What is the effect on the monthly Profit and Loss statement from this?

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang
(c)Copyright 2008, Dr Lisa, Inc. All rights reserved.

_____________________________________________
About the authors:
Brad Stillahn is a business owner that has successfully implemented Goldratt's Theory of Constraints (TOC) methods in his own business and is now helping other business owners do the same. His consulting company, TOC Professionals engages in long-term relationships with companies implementing TOC. His business and personal partner is Dr. Lisa Lang. Brad can be reached at Brad@ScienceofBusiness.com or 303-886-9939.

“Dr. Lisa” Lang is President of the Science of Business. Her speech “Maximizing Profitability” is popular with Vistage groups and as a keynote speech. Recently Dr. Goldratt’s Global Marketing Director, she offers the “Mafia Offer Boot Camp” for companies wanting to develop and implement a Mafia Offer. She can be reached at DrLisa@ScienceofBusiness.com or 303-909-3343.