What’s it all about?
A technique typically used in factories to ensure that when there is something limiting production that we prioritise the products that are going to make the greatest contribution. It has applications in all business situations though.
In essence this is ‘contribution per unit of limiting factor’ in another guise, applied to more complex situations than just a shortage of raw materials, applied to circumstances where you can fix the shortage problem because it is part of the process.
Most examples will be of Throughput Accounting (TA) applied to not having enough time on the machines in your factory to make everything (bottlenecks). This is because it is easier to understand and calculate in these scenarios, but it does apply in any situation where there is a process taking time, so applies to services too.
It’s all about the bottlenecks.
If we don’t have enough time to make everything we want to make then we have a constraint, a limiting factor = the time available. The bottleneck in the process is the machine where there is not enough time to do all the work. If there is more than one bottleneck, then the one we are worried about is the biggest one.
I’ll work through a question step by step to illustrate the calculations as we go along.
What do we do about bottlenecks?
We don’t really want to live with them, after all it means we are not able to produce as much as we would like and that means we are not going to make as much money as we would like.
- Slow down.
There is no point having piles of partially finished work everywhere, so we will slow the whole process down. Not to the speed of the bottleneck machine, but a bit slower so that the backlog of partially completed work can be cleared. This may mean you have some people idle for a while, but that is better than making Work in Progress that you can’t finish.
- Fix the problem
Rarely is the bottleneck the fault of the person on that machine. it is much more likely to be a problem with the machine or the process. for machine, think of a photocopier that keeps jamming – it’s going to need repair or replacement. For process think about how you can make things run smoother by having a better designed process. is the person on the bottleneck slow because they have to do a task that could be done by someone else (e.g. do they have to open boxes? Could the components come to that machine unboxed. Anything that could save time? If it is the person, the most likely cause is inexperience or lack of training – train them!
- Speed up
Once you’ve solved the problem you can speed the whole process back up again – until there is a problem somewhere else!
Not just manufacturing.
Bottlenecks don’t just have to be points in a production process where stock levels are building up. In any business there might be a point where an individual or department is unable to deal with all the work coming their way. Work will be piling up, people beyond them in the process may not have enough to do and overall the business isn’t making as much as it should be.
Here too we go through the process of identifying the bottleneck, slowing down and prioritising what should be done while removing the constraint.
“Stock is a symptom of inefficiency”.
There’s no point in making things you can’t sell and there is definitely no point in making things you can’t finish (Work in Progress). So we would scale back production to match the rate of the bottleneck machine. Remember, stock costs you money (the Direct Materials).
(Remember, videos like these that are produced to cover whole topics may include material that isn’t relevant to your own exam at your institution. don’t get hung up on it
Interesting comparison to Marginal Costing in this video, at around 9 minutes in. This comparison might help you understand Throughput Accounting.
I am not sure I agree…
Much of what I have read about Throughput Accounting says that you don’t make a product if it’s TA Ratio is less than 1.0.
For example this comment from the ACCA:
“Where throughput accounting principles are applied, a product is worth producing and selling so long as its throughput return per bottleneck hour is greater than the production cost per throughput hour. This may be measured by the throughput accounting ratio. Where the ratio is less than 1·00, return exceeds cost and the focus should be on improving the size of the ratio.”
I just say, what happens if you stop making the product?
The only thing you save if you don’t make a product is the Direct Material costs of the product, and we’ve already taken those out of the equation as we are looking at Throughput (sales – direct materials). So, actually we don’t save anything. All the other costs are treated as Fixed. If you don’t make a product you are still going to spend the same amount of money on Labour and Overheads. Provided you’ve got a market you might as well carry on making things, at least you will get some income towards paying the Labour and Overheads.
Or am I missing something?
You can see a calculation that demonstrates this in my working demonstration above.
Listen to these
Using the concept of Throughput Accounting in other situations is covered too in this series of podcasts. At least listen to the first so that you understand how a bottleneck can apply in any business, it’s not just about slow machines! Also a good summary explanation of bottlenecks at the end.
Podcast 1. Throughput. Steve Bragg from AccountingTools.com
The podcasts get more detailed as they go on, with good stuff in Part 5 for practical application in a factory (the controls and reports you need) to ensure you are maximising throughput. Beyond what you will probably need for your studies, but we are interested because we love management accounting!
Podcast 2. Throughput. Steve Bragg from AccountingTools.com
Podcast 3. Throughput. Steve Bragg from AccountingTools.com
Podcast 4. Throughput. Steve Bragg from AccountingTools.com
Podcast 5. Throughput. Steve Bragg from AccountingTools.com
(Articles and news items related to this topic to put it in context for you). Remember, there may be some variation in terminology. Some use the term Return per Factory Hour (minute) rather than Throughput per Factory Hour (minute)
A bottleneck on the tube, the solution? Step 1. Slow the process down.
By only allowing standing passengers now arrive at the exit gate at the speed of the bottleneck (the exit gates). Step 2 is to solve the exit gate problem.
The consensus on this topic: https://en.wikipedia.org/wiki/Throughput_accounting
Here is a journal article that goes into developments in throughput Accounting in some depth. Search ont he title as there isn’t a pdf of the paper that I can share with you.
“Optimal product mix decisions based on the theory of constraints? exposing rarely emphasized premises of throughput accounting. emphasized premises of throughput accounting”
Possible Written Questions.
(No indication of marks – the more marks a question gets, the more you are expected to write – detail that is, not just words!) If you can’t answer these, you need to do some more reading. I do ‘find’ questions elsewhere, so these aren’t all questions I have used myself.
What steps should a company take when they have identified a bottleneck in their processes?
Comment on the use of Throughput Accounting Ratios.
(Relating to calculations you will have just done in a Throughput Accounting question) – Explain how the method you have just used (TA) ensures that you make the most profitable product mix.