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Constraints accounting is a management accounting technique based on Eliyahu Goldratt’s theory of constraints. This technique involves the identification of constraints that limit a firm’s production output. The removal of constraints allows for higher production output and lower individual costs for goods and services. Constraints accounting is also known as throughput accounting. When a company achieves increased throughput, more profit is available for reinvesting into the firm, and unnecessary expenses should decrease through fewer constraints.
Goldratt’s theory of constraints contains five basic principles. Identify constraints, exploit the constraint in a positive manner, align the organization to support constraint decisions, break constraints when possible, and focus on continuous improvement. This process allows a company’s management team to decide the best approach for limiting constraints that will hamper the production process. Under constraints accounting, the focus is often on the financial constraints within a firm.
Three basic questions are present when applying the theory of constraints to constraints accounting: how to increase throughput, how to reduce investment, and how to reduce operating expenses. Throughput means producing more goods or services with the same level of inventory on hand. Improvements in product quality and skilled labor can often result in less waste and better throughput. Lower investment should be made in fixed costs. Variable costs allow for more money in the company’s coffers as capital is only spent when production occurs. All operating expenses outside of production materials should also remain low.
When focusing on constraints, companies should concentrate on those under their control. For example, constraints accounting cannot provide information for the lack of available credit, purchasing power of currency, threat of competitors, or government regulation. These factors are all external and may not be easily corrected by the firm. Companies should only attempt to remove the constraints within their own systems that hamper them from operating at maximum efficiency. The result should then be the lowest-cost goods or services that will provide the opportunity to increase overall profits.
Constraints accounting is not without its flaws. One flaw may be spending too much time on administrative tasks in favor of actually improving production processes. This results in potentially profitable ideas that never transfer to the actual production stage.
The opposite of this flaw is also possible. A company may completely overhaul their firm and then remain content with the initial changes. Inertia can then set in as the company fails to continue improvements. This can result in a major overhaul at a later time, increasing operating expenses.