In Throughput Accounting, everything starts and ends with cash. You are done once you have collected cash. Cash can be a resource as well as a constraint. When cash is a constraint, nothing else matters. It becomes the only active constraint!
We all know what to do when we are short of cash. What all of us have forgotten is how to make cash. This is the gist of this article, and the gist of Throughput Accounting.
There is a cycle to cash. It has been illustrated by the most notorious authors in the field of Throughput Accounting with the ‘Pools and Flows of Money’ diagram. I was inspired by all the variations of this diagram to come up with my own version:
The journey taken to create this diagram helps us build a complete picture of the asset and liability pools, some sources of funds, flows of money, as well as the Income Statement and the Balance Sheet reports!
Although all authors are coherent within their own variation of the traditional ‘Flows and Pools of Money’ model for manufacturing shown above, there are a few – sometimes important – discrepancies or omissions. I am sure my version also has its flaws.
The illustration can apply to companies in almost every sector of the economy that manufactures or creates physical goods. It can also work —at times— in the service industry and Knowledge-Work with some adjustments depending on context.
As we have discussed before, TVC seldom applies to Knowledge-Work. Seldom. But it will in the example we will build for the agile ‘coaching’ market. Also, the notion of Investments, Inventory and assets can take a turn for the unexpected depending if a full-time employee develops products that are sold (software) to external clients (No TVC) or if he bills on a time and material basis while on customer site, in which case his timesheets become TVC for billing purposes to the external clients albeit his salary for internal management purposes should be considered an operating expense. The ‘Flows and Pools of Money’ diagram can take a new twist that I will try to render as best I can.
We must now cover both last 2 applications of Throughput Accounting: the Accounting System and the Financial Application facets, something we have not done thus far. The aim of which is to figure out how to leverage our existing brown money and ‘launder’ it into green money! The mechanics and reflexes and rewiring of the brain require getting physical with the model and do some easy math while applying to the letter the five focusing steps and their positioning with green and brown money. And all this while mastering the ‘Flows and Pools of Money’ diagram, which I must repeat again is the best kept secret of the accounting profession.
In this first section, we need to revert to the visible and physical world. Of course, we will dive neck-deep into Knowledge Work, but some key principles need to be clearly explained using a brick-and-mortar example.
We all know that the most challenging step for the Five Focusing Steps for Knowledge Work is to Identify the constraint, as it is invisible. We have discussed remedies to this problem. When we are in more traditional and visible contexts – where inventory is actually palpable – subordinating to the constraint is most difficult as it requires us to change mental models. This applies in Knowledge Work as well.
But isn’t Throughput Accounting all about making more money rather than subordinating to the constraint?
This is where the Exploitation step comes in. In order to increase sales by a factor of five, the most commonly used path is to multiply by five your capacity, your workforce, and operating expenses. The profits will increase by a factor of five as well. A linear scale, no more! A zero-sum game.
This has everything to do with step four: Elevate the constraint. This can be pricey. But it may come to that at some point.
Or we can go for a free ride and Exploit the constraint with brown money – using existing capacity and operating expenses - and get five times the bang and ride a quadratic curve.
Let visualise this:
Why did I not think of that, you might ask!
Well, this has everything to do with a flawed mental model that is deeply rooted in the fabric of society. I will explain this by adapting Albert A Bartlett’s words of wisdom:
The greatest shortcoming of modern management is our inability to understand the capacity function.
Earlier, we discussed how Cost Accounting has a habit of changing the behavior of the capacity function, whose curve is ALWAYS a flat line. Capacity is expressed under the (OE) – Operating Expenses - component of Throughput Accounting. It is the sum of the resources that you put at the disposal of your employees to help them perform, to provide them with a decent working environment where they can perform! After understanding this sentence, one would ask: “Why should we cut there to increase productivity, which leads to profits?”
Throughput Accounting views capacity as a financial lever that has been forgotten by the accounting profession. Indeed, Cost Accounting distorts input capacity — which is already paid for — and output capacity, which is free to use. In doing so, Cost Accounting tightly couples Operating Expenses with Sales. Nonsense!
This brings us back to our Expansion vs Growth discussion of a few paragraphs ago, where we aimed to get five times sales at no extra monetary outlay. To do this we need – in our heads only – to decouple (T) – Throughput, from (OE) – Operating Expenses as shown below.
The illustration above demonstrates that simply moving the fulcrum to the right (as in the bottom-right corner) achieves greater productivity (which leads to prosperity) without affecting Operating Expenses!
The path to exponential growth lies not in increasing Investment (as we are first inclined to do). It lies in sticking to the first three steps of the five focusing steps as shown below:
Exploiting the constraint is the cash cow. Especially for knowledge-work enterprises.
Remember the first illustration? It will be shown again just below with a purpose. We have now created an increase of 24% in sales – by applying the first three steps of the five focussing steps - in the service industry (Banking, Hospitality) with the following parameters:
Let’s see what an increase in sales of 24% does to Net Profit under GAAP. Again, remember that TVC seldom applies in the service industry or knowledge work.
This diagram illustrates the case for a company without TVC that increases sales by 24%. The results? Net Profit under GAAP goes up by 240%. If you can easily get an increase of 10% in sales – extremely feasible in knowledge work or the service industry - the results on Net Profits under GAAP will be 120% in the model used.
The detailed calculations are shown below.
The results seem impressive. But if this company wished to acquire a company 1.5 times its size, it could do so thanks to its TOE spread! (Difference between (T)hroughput and (OE) - Operating Expenses). We will address the significance of the TOE spread further down this article.
Going through the ten or so steps required to build the illustration at the beginning of this article is time consuming. It requires attention and intellectual effort. The Powerpoint link to Henry Camp’s and Ravi Gilani’s succinct ‘build-up’ of the illustration is provided in the References. The well-articulated article by Dr Kevlyn Youngman on the same premise can also be found in the References. They are both worthy of the best ‘walk-thru’ of cash in a company.
Set aside time to digest the material in Camp, Gilani and Youngman’s articles if you desire a detailed analysis.
You can also find my new ‘consolidated’ model in Appendix A where I took the liberty of assembling a more recent version based on all the existing artefacts available. I took some items out, left many untouched and added a lot of my own thinking. And for the finale, at the conclusion of this article, we will create one for our business case.
We now must see how we can change the market participants’ motivation and behaviors in the agile coaching market with Mafia offers. Once this is done, we will come back to drawing the proper ‘Flows and Pools of Money’ diagram where a head-hunter serves as the matchmaker between the client and the agile coach, who is a freelance consultant.
There is a lot of money trapped in the agile coaching market. Unfortunately, we all operate in a Time and Materials model. The time has come for clients to dictate how business is to be made so that a bigger share of the pie becomes visible to all market participants.
This section challenges the current, flawed mental model of the agile coaching (with or without a team) consulting market. It will be painful for some readers but at the end, we will be reminded of Ravi Gilani’s words of wisdom: Make more and more money over time.
Mafia offers have characteristics of their own:
A Mafia offer is not/does not:
To develop a Mafia offer, you need three things:
Let us now proceed with the matter at hand. In the coming discussion, I am not entertaining the case of agile coaches being hired in a context of ‘staff augmentation’. The agile coaching resources that are part of this discussion are ‘specialists’ to provide value for a new, in-development context or project. Too often, clients hire consultants with the ‘unconscious’ aim of controlling OE – Operating Expenses. It is a flawed mental model that is innate. When hiring agile coaches, one should do so in a revenue growth perspective. We need to get there. This onus is on the client.
I will focus here on the Agile coaching consulting market, a subset of IT consulting. There are three partakers:
We operate in a market where Revenues = Price x Quantity. This is a linear model. If only there was a way to change all that and make the pie bigger. This is where ToC Mafia offers come into play. Everyone ends up with the upper hand, and better off financially.
The core problem is revenues. When you work in a revenue protection mode - as head-hunters and consultants do – you are in fact operating under a ‘cost-plus’ scenario. Cost-plus scenarios do one thing extremely well: passing inefficiencies onto the payer and providing a motivation to extend services for those who invoice.
Nobody likes to be on the short end of fixed bids. The consultants do not want to bear the risk of being paid on a deliverable basis. The head-hunter, outsourcer or consulting firm that has managed only one such fixed bid contract is not crazy enough to do it again and enter a bidding war. The catchphrase ‘out of scope’ comes from this model. Plus, the business relationship with the client is fragile and difficult to maintain.
Clients and fixed bids? They love it. Their business risk is shared. The more the better.
The only way we can all get around this illiquid market is to generate more money for all participants by competing on time and revenue/benefit sharing. That is only possible if you have a recipe that works, that is repeatable, that has causality. A bit like science.
Throughput Accounting and the Theory of Constraints have these traits. They are based on science. Once you start, you are already near the finish line. Results are repeatable and predictable.
So here is the Mafia offer. Everybody wins in the end. And especially the talented workers who, for lifestyle reasons, enjoy permanency and stability. They will learn from the best consultants in short bursts, after which those consultants will then move on to the next, more rewarding mandate, putting an end to their main stressor which is the ‘in between’ mandate idle time.
The key is to understand the revenue and/or cost function of the client (the client must be forthcoming) and to find out how much cutting Lead Time by more than 20% in one month is worth. That is the first fixed bid mandate. Risk sharing means revenue sharing. That is problematic for the client as they are not used to spending money that way.
When the first month has shown great success, then a second mandate of two months can be contemplated with, let’s say, an increase in Throughput of 30%.
Finally, a three-month mandate can seal the intervention with more of the same, while focusing on more details of the Five Focusing Steps and Throughput Accounting.
Then, on to the next customer.
The client has paid the same amount that was usually spread over years but earned the economic rewards now; the consulting firms now have a new business model based on repetition of high margin gigs; and the consultants can live a ‘stress free’ career as they know they simply need to step up to the plate to hit a home run. The friction between mandates when they are short on revenues is more than made up for by the enhanced revenues they actually make while working half as hard.
On this account, the head-hunter or IT outsourcer can now enter into fixed bid contracts at no risk. The number of contracts is multiplied, and by not doing clerical work but participating in finding value in proposals that show understanding of their clients’ path to prosperity, the quality of their revenue stream goes up, which is what they are ultimately looking for. But the accounting – and ‘Flows and Pools of Money’ diagram would look different for each of them for the following reasons:
The results are anticipatable. So are the revenues, which is what is sought in the first place. There are plenty of clients who want these kinds of results in a short time span.
This is doable. But the lead must come from the clients as the head-hunters and consultants like their business models as it stands. Clients want growth and risk sharing, not an extra layer of overheads. And HR wants happy employees who can better themselves and increase their market value. HR does not want consultants disguised as full-time employees at twice the salary for mandates that last years.
The current business model offers linear results. It cannot be otherwise. Let’s embrace geometric growth and prosperity for all by using the alternate Throughput Accounting formula for Revenues:
Revenues = Quantity / Time spent at the constraint per unit of time
The money is there! We just need to convert it faster and do more repetition in the same timespan.
We will address the new “Pools and Flows of Money” diagram for the head-hunter in the next section. There are significant changes to be made compared to a standard ‘made for manufacturing’ diagram!
When I was juggling options as to how I would ‘sketch’ the diagram for the agile coaching market, I came up with a few variations. But we are all heading for a ‘cash generating’ business with the use of T Generators, in the true spirit of Throughput Accounting.
In our case, the INVESTMENT box would be replaced by intangible assets linked to knowledge of the Theory of Constraints, Throughput Accounting, MAFIA offers, 5 FS etc.
T Generators (Throughput Generators) apply in all contexts. It is a new concept that hit the market in 2019. Through this new optic, no links exists between the inputs, the processing, the outputs, how it is sold and how much it is sold for. It fits knowledge work like a glove when you match it with Mafia offers! Every situation requires a new mind set. They remind me of Mafia offers.
This is exactly how we should label the old green INVESTMENTS box. There are, of course, tangible assets that can be developed such as pricing models, RFP templates and the likes. These fall under the category of ‘tangible’ assets but are immaterial from an accounting point of view and could be treated as OE instead of I.
Sometimes, new vocabulary is needed to reflect new realities. We are all familiar that OE turns I into TH. Sadly, it does not apply to our head-hunter reality.
Our case is more like ‘where TVC (agile coach billings) generates TH with no I’. Is it not?
Throughput Accounting has passed the test of time and works well for the service industry as well as for manufacturing. For Knowledge Work, we may be exposed to challenging hiccups.
In the case that we are building, centered on Mafia offers for a head-hunter that hires all the resources they require to make a markup. In fact, this head-hunter is like a software distributor that would have no warehouse, no trucks, no ownership of the assets they sell and offers no support. In fact, the product generating green ‘INVESTMENTS’ box in their ‘Flows and Pools of Money’ diagram would simply be a plain ‘markup’ engine! Our software distributor is just a pivot. So is our head-hunter, a facilitator.
T Generators are discussed at length in the book ‘Throughput Economics’ that can be found in the References section. We have also a pretty good idea of what a Mafia offer is. They have so much in common that I believe that this is what creates value to our new ‘Flows and Pools of Money’ diagram.
Each Mafia offer is different and priced as such. T Generators are also to be considered products that are different between themselves in terms of market value.
Strikingly, in both cases it is mandatory to differentiate between what is produced and what is being sold. The perceived value of the product for each market condition is more important than the process or its inputs!
In both cases, that which is sold is referred to its name: Mafia offers and T Generators.
But one thing is interesting: T Generators is where we ‘make’, ‘assemble’ and ‘build’ products. A bit like our old INVESTMENTS green box. The difference would be in the scale of the selling price. You can only add so much value to transforming a piece of wood, but shaving 30% off Lead Time is a different value proposition each and single time a Mafia offer is made to each client! There is no common denominator!
There are so many affinities between the ‘products’ being created with Mafia offers in our agile coaching market and T Generators that the ‘INVESTMENTS’ green box in our diagram needs to be labelled as ‘T GENERATORS’.
As one can see, the model has been stripped off to overemphasize the fact that we are heading into a ‘cash’ business. Every time an opportunity occurs, the forces prevailing in the market take over.
The expression above comes from Glenn Menzies, a colleague whom I worked with in the Insurance industry a while back. I never heard it before I met him, and I really think it illustrates the case I am trying to make.
We have addressed in length (T) – Throughput and (OE) – Operating Expenses, but where does (I)nvestments fit in all this? Curiously, there is an ‘I’ link with T and OE!
But first, we need to come back to the ‘material’ world and take the example of companies that work in project mode to acquire new capacity. The banking and insurance market come to mind.
We have addressed the fact that capacity is a flat line. It is until we need to augment it. At this juncture, the capacity function is better represented as a staircase:
When the need arises to increase capacity for servers when the bank or insurance company hits the ‘red arrow’ points above, one project must find the money to purchase the capacity that suits the corporate needs. If a project needs a bit, it has to buy a whole lot of capacity for everybody else. This is the way that corporate architecture guides the growth of overall capacity. This makes sense. Up to a point.
The negative impact of such an approach is that when the time comes for adding capacity, projects that are less ‘fortunate’ will hide in the hope that someone else will find the money. This creates accounting f(r)iction.
This scenario is not well suited for Throughput Accounting as the economic life of the incremental (I) - Investments or (OE) – Operational Expenses must be matched with the additional (T) – Throughput generated in the targeted period. Buying capacity for the entire bank does not serve the Throughput Accounting model. What are we to do?
The spread between T and OE – usually referred in TA as absolute profitability (Net Profit) – is the answer to where to look for finding the money for I! As T is decoupled from OE, new money is injected into the system. As T is decoupled from OE, the index of productivity (T/OE) goes up in a non linear pattern as well! Herein lies the key to Elevate once you have done all that could be done with the archemedean lever of the first three steps of the five focusing steps! Now is the time to invest in capacity with the TOE (T minus OE) spread and give some thoughts to increasing I in that fashion and not resort to individual projects to get delayed and lose Throughput as a consequence. Now is the time to Elevate. Resorting to external financing should be contemplated when the TOE spread is lacking.
As a concluding remark, nobody becomes Albert Einstein overnight, not even Albert Einstein! Today, we all benefit from his knowledge, thanks to the advances of society. No need to travel the path of relativity.
The same applies to the teachings of Dr Eli Goldratt and his many followers today.
The GOAL, the first book published by Dr Goldratt, included this sentence: “Make more money now and in the future”.
It may have a negative connotation, but it was spoken to a friend who in the early 1980s – where stagflation and record interest rates were intolerable – was struggling financially. Later, he would admit that all his work was made to help humanity achieve better economic prosperity, so we could all have better lives at home, at work and within society.
This body of knowledge is within reach for all of us. The time to reap the benefits is quick. This knowledge is the ‘software’ that runs the T Generators in the new ‘Flows and Pools of Money’ diagram since intangible assets must take the place that is owed to them.
It is time to realize the unrecognised positive impact of operations upon finance by decoupling T – Throughput from OE – Operating Expenses to pave to way to finance more I - Investments. The TOE spread is the secret to self financing of (I).
I would add to this that you make green money with brown money. It is something I feel we need to stress. Slight adjustments requiring no cash outlays can go a long way toward exploiting the constraint.
It is also time for participants in the agile coaching market to think about exploiting the constraint for growth and productivity – as we have debated in the first section – instead of thinking in terms of cutting Operating Expenses and using agile coaches as workforce augmentation for a mere markup…
It’s time for Mafia offers. Let the market clients decide. It will take courage, but it can be done.
One last thing, when making Mafia offers 1) you should always stress why your client would benefit from doing business with you and 2) making outrageous guarantees are often – not always - part of Mafia offers!
- Daniel Doiron, CPA
I love systems, enjoy measuring improvement while embracing teamwork that actually works and find its way on the bottom line! Throughput Accounting helps me get Unity of Purpose within teams and organisations.
I am bringing Throughput Accounting to CPAs, CxOs and Agile Center of Excellence.
For more on Throughput Accounting for Knowledge-Work, visit https://www.agileagonist.com/
This appendix deserves a bit of history. The ‘Flows and Pools of Money’ diagram is a major artefact in Throughput Accounting. It is not given the light and importance that it should have and, frankly, all CPA and CxO level executives ought to understand its mechanic.
If you Google ‘Throughput Accounting Flows and Pools of money diagram’ you will get nowhere.
It is the best kept secret of the accounting profession.
 For those interested in the topic, a great article by Eli Shargenheim and Ravi Gilani can be found here: https://elischragenheim.com/2017/05/11/evaporating-an-active-cash-constraint/
 The content of this article is inspired in part by the writings of Dr Kevlyn Youngman and John Ricketts, whose works are included in the References section. The adaptation to agile and MAFIA offers is entirely mine.
 Henry Camp and Ravi Gilani, Dr Kevlyn Youngman and Eli S Schragenheim have all used this fundamental model in one form or another in their work.
 ‘Pool’ is meant to note the static nature of assets trapped in the company’s Balance Sheet, as opposed to ‘flow’ which describes movements of money, represented on the Income Statement.
 The color densities also have significance. For a short explanation, see the diagrams of both Gilani & Camp and then Dr Youngman
 Green money and Brown money were discussed in the ‘Color of Money’ article.
 Subordinating to the constraint prevents us from overproducing and keeps WIP in check!
 One of the better articles contrasting Subordination and Exploitation is by Dr Kevlyn Youngman in the References section.
 The original quote being: "The greatest shortcoming of the human race is our inability to understand the exponential function."
 All accountants understand the power of capacity financed by debt. It is a basic knowledge in fiscality.
 I am using (T) instead of (TH) to denote Throughput as I did in the previously. The reason will be obvious at the end.
 The logic is that the first 100 points of Net Profit generated will be kept for internal growth of the existing company. So we are left with 150%, which is a company 1.5 times your size!
 Mafia offers are a formal topic in Throughput Accounting. Dr Lisa Lang is the world’s expert on this topic. It is the subject of Chapter 22 of the ToC Handbook. Some links https://www.slideshare.net/enterpriselithuania/building-mafia-offers-for-sm-bs-presentation and https://www.slideshare.net/enterpriselithuania/how-to-prepare-mafia-offers-under-lithuanian-circumstances-red
 “A mafia offer is an offer that is so good that your customers can’t refuse it and your competition can't or won't offer the same.” Dr Lisa Lang
 I have spoken with numerous head-hunters and consulting firms about the solution that I am presenting. I got the cold shoulder, as my solution would destroy their business models. Consultants as well. The change from the market must come from the clients who pay and must demand Throughput! I know the clients would welcome the change as I have spoken to many of them.
 T Generators are discussed at length in: Schragenheim, Eli and Camp, Henry and Surace, Rocco. ‘Throughput Economics: Making Good Management Decisions’. Routledge, A Productivity Press Book. 2019
 T-OE spread. A new term to indicate how increases in Investments ought to be financed while also giving an incentive to decouple T from OE!
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