Throughput accounting is a new concept relating to the basic principles of management accounting. This accounting concept was developed by Eli Goldratt, an Israeli business management guru and originator of the Theory of Constraints management method. Goldratt’s throughput accounting theory transforms the traditional focus of cost accounting from cutting costs to an accounting method that attempts to maximize output. Throughput accounting takes the organization’s ideas or goals and determines how to best increase the production output from each idea or goal to maximize the economic wealth of the company. Goldratt’s Theory of Constraints management method is an important foundational building block for throughput accounting.
The theory of constraints management method is based on five different steps. The first step is to identify the constraint limiting the company’s goal or objective. The second step is for managers to decide how best to avoid the constraint and limit the company’s resources from being wasted on the constraint. The third and fourth steps involve setting aside minor business constraints and putting the biggest constraints first when improving business methods. The fifth step should be the result of having the major constraint removed from the production process; if the constraint still exists, the company may need to start over on the theory of constraints process.
Throughput accounting applies the theory of constraints management method to the cost accounting functions of a company. Constraints may include the company’s ability to purchase business inputs for raw materials, finding sufficient labor to produce goods or services and the ability to develop efficient and effective production processes that limit the waste of precious economic or business inputs. Throughput accounting does not necessarily focus on maximizing individual profits from goods or services; its main focus is to lower the business investments or expenses found in the production process.
A business investment often represents capital that is tied up in a company’s assets or production processes. Throughput accounting attempts to limit the amount of capital spent on business investments so more economic inputs or resources can be purchased for the company’s production of goods or services. Excess amounts of raw materials inventory may also limit the company’s ability to produce goods and services since capital must be spent on warehousing the inventory. Throughput accounting also focuses on reducing operating expenses. These expenses may be excess labor and maintenance or utilities expenses that are not related to or necessary for producing goods or services. Freeing up capital through decreasing business investments or operating expenses is an essential part of throughput accounting and how it can positively affect the company’s overall economic value.