Have you heard the story of the CEO that had a $280 million budget but not a penny to spare? There is green money and then there is brown money. What kind of money is your Improvement Initiative ‘bringing’ in? What kind of money is your Improvement Initiative ‘using’?
This is the angle that Throughput Accounting takes with Improvement Initiatives. Some of them will aim to save ‘man days’ or become more efficient in the back office by closing the books faster (brown money that will not find its way to the bottom line but can nonetheless give you a tactical, competitive advantage).
Being efficient will likely get you more output per input and get things done faster, but it remains to be seen if this will translate into improved cash flows.
Those initiatives sometimes show nothing in terms of financial Throughput, though operational Throughput is observed. By all means, those brown projects still have merit and are required. This is a distinction with a difference. People do not pay attention to the color of money. And they should. Throughput Accounting accomplishes this by having you wear the hat of a financial analyst, base your decisions on the marginal impact of your actions and perform all your accounting on a cash basis.
The kind of Improvement Initiatives that I want to target are those which have a lot of value, as well as a scientific foundation. Lean aims at reducing waste, Six Sigma at reducing variation. It works best at the constraint.
I am all for immediate gratification in any Improvement Initiative when we can show results early on the path to these long journeys. This is one of the great benefits of applying the Five Focusing Steps to Throughput Accounting. Benefits are fast coming in terms of green money. In terms of costs, brown money can go a long way.
As I have mentioned in earlier articles, there are seldom any new cash outflows required with the first three steps: Identify, Exploit and Subordinate. Drawing on existing capacity and operating expenses is not a use of new funds in Throughput Accounting as there is no delta (OE) – Operating Expenses and delta (I) - Investments. Green money gets generated very fast and this is a source of new funds.
All decisions made with Throughput Accounting have one driver: money, much more green money coming from outside the firm.
This is important to realize.
In this article, we will introduce additional Throughput Accounting principles, formulae and new reports in the context of Improvement Initiatives. But first, let’s see how our flawed mental models are causing our own roadblocks.
In a Knowledge-Work setting, we need to maximize each of our value streams for Throughput. After showing discipline as to when to start and stop work, a fictitious company was ready to move on to the next step.
Everybody was pleased with the 100% Flow Efficiency metric now that all the Wait Time in the process was eliminated. It was time to focus on an improvement initiative to ‘work faster’, shaving time off the eleven days process’ overall time.
To that effect, the VP of operations asked for two Improvement Initiatives to be provided ASAP. Mike and Jane are assigned to the task.
The Lead Time of the three-step process, which takes eleven days, is illustrated below:
Mike and Jane’s proposals are highlighted below:
Mike’s proposal cuts two days off the baseline at a cost of $1,000. Jane’s adds one day and costs $10,000.
Jane and Mike were summoned to the executive floor to meet with upper management once their reports were completed. The meeting did not take long, as the C level executives were all about to leave for a retreat. Mike met no resistance from the board, and his proposal was retained and to be implemented in earnest. (Jane could not attend that meeting for personal reasons and would return to work in a month.)
Mike was directly impacting step three, which meant the delivery step was truncated by two entire days! Jane’s alternative increased step three by a day, a solution that will no doubt frustrate customers. No half-decent Improvement Initiative can afford to further alienate the market.
A six-iteration cycle takes 36 days to complete as reflected in the CFD - Cumulative Flow Diagram - below:
The following CFDs – Cumulative Flow Diagrams - show the impact of Mike’s two-day Improvement Initiative as contrasted to the baseline:
The problem with dealing with initiatives that bring end to end Lead Time down is that they are not evaluated on Throughput. Jane’s proposed solution of increasing overall processing time by one day would be considered as waste under Lean, as additional time is always considered as waste. Mike, by shaving off one day, falls within the boundaries of Lean’s thinking as delays and wastes are directly proportional. One less day of Lead Time is a day of waste eliminated.
If we remind ourselves that the constraint is always the place in a process that has the lowest capacity - or longest cycle time - we can see that step two is in fact the constraint.
Mike is shaving off days from step three, away from the constraint.
Let’s consider Jane’s proposal which in fact reduces one day at the constraint despite increasing overall Lead Time by one day. Both steps one and three are upped by one day!
We can see that four days are saved in lieu of Mike’s two days after six runs!
But this is selling Jane short. Let’s project these savings through 50 runs.
We see that Mike’s solution, costing $1,000, is saving a day and this is the cumulative impact. However, Jane’s approach saves 48 days after 50 runs! An impressive feat compared to the two-day, noncumulative improvement that was approved. And after 100 runs, results will still be felt.
But there is something unusual in Jane’s solution. We now see that all three processes take four days! Are we faced with three constraints? Weren’t we told that there is one constraint?
Jane is a Throughput Accounting specialist and her answer is worth listening to. In fact, we are in a situation where we have three bottlenecks, or no bottleneck.
Let’s bring back what the definition of a constraint is:
Constraint: The bottleneck (maybe one of many) that shows longest Lead Time or the smallest Capacity.
We can finesse this definition further to justify the situation:
Constraint: The bottleneck (maybe one of many) that is actively managed!
What Jane is confessing to is that the constraint before the Improvement Initiative was at step two, and that it will remain there and be actively managed for the time being! Steps one and three are not actively managed and are therefore not to be considered as constraints.
In retrospect, Mike’s solution is simply left-shifting the delivery line by two days. There will never be a cumulative effect. Two days is all there is.
Jane is augmenting the slope of the capacity line and will gain an extra day from the third iteration onward. The rate of delivery is always dictated by the constraint, which Mike did not take into account.
The mechanics of Throughput Accounting are unique as it is the only branch of accounting that totally bans cost allocations. It is also the only accounting discipline that does not have a Handbook, an oddity! Recently, Etienne Du Plooy provided a list of nine Throughput Accounting concepts that are key to shaping our understanding and that I will provide verbatim:
FAK CHEK is a fictitious company offering credit ratings on customers who have double citizenships. In recent years, the international market has seen an increasing amount of fraud and ‘abuse’ from borrowers having double residency status, taking loans in more than one country and increasing their risk of default. The ADDA – Anti Double Dipping Act – has been enacted as law on an international scale and the penalties for both lenders and borrowers of funds are severe. Now, all borrowers must indicate all their nationalities on their loan applications.
FAK CHEK has a unique process and value proposition. It is forwarded these applications the world over from lenders of funds who subscribe to the contract free service on a monthly bill, based on the number of cases processed. It offers an SLA of less than 12 hours, which they always respect. The GOAL now is to generate more operational Throughput as world demand is exploding.
FAK CHEK’s CEO, Mr Bounce, calls two consulting firms to provide alternatives on forging ahead. The winner will be awarded the contract.
CoD, the first company, sends their representative Charles. The other company, ToC, will be represented by Tanya.
FAK CHEK is small. Managerial expertise at the operational level is thin. But Mr Bounce is not afraid; what he lacks in terms of expertise on the floor is more than made up at the financial level by the CFO, Mr Frik, a Middle Eastern businessman who used to run the biggest bank in the world.
The current process is depicted as follows in four phases:
The process was presented and explained to both Charles (from CoD) and Tanya (from ToC) after they had signed an NDA. Both consultants were given full access to technical, process and data volume information.
The Lead Time per inquiry was ten hours and Flow Efficiency was excellent. And never in the history of FAK CHEK was the SLA of twelve hours not respected. This had to be a constraint for the consultants, Charles and Tanya.
Another constraint was that the capacity of 5840 hours per year be maintained as adding capacity was an issue with the current application portfolio.
Charles and Tanya are impressed with the technical prowess exhibited and are ready to come with their respective plans as follows:
Everybody is impressed with Charles’ proposal as it would further secure their twelve hours SLA. This gives him the spotlight, allowing him to present his case first. Tanya will present the next day.
In terms of operational Throughput, the additional cash inflow from 65 inquiries per year is a very good scenario, as opposed to Tanya falling short by 53! Mr Frik, the CFO, is smiling after the presentation. Mr Frik never smiles. But he knows that the basic formula for Revenues is equal to Price x Quantity! That means 65 additional requests per year. At the price FAK CHEK is charging, everybody – including Mr Bounce – is happy.
The next day, Tanya presents additional data to the attendees. Mr Bounce and Mr Frik are not impressed with the additional day that her proposal would impose, but are willing to listen to her anyway.
Tanya starts by thanking Charles for his presentation and salesmanship acumen.
She knows how to handle Throughput Accounting’s counterintuitive paradigm. But ‘brain pain’ must be served first. Otherwise, the battles linger for too long. She likes the nuclear approach.
She begins her meeting with a shocking sentence: ‘We live in a constrained world. If such was not the case, we could not make a single sale!’
Tanya knows what she’s doing. She first must unyoke them all. Set them free from their mental models.
She lets them scramble for a while to show them what she means.
She argues, “When Mr Frik said yesterday that Revenue = Price x Quantity, he was roughly right and precisely wrong.“
Mr Frik is known for one thing: he likes challenges and never turns one down. “Humor me, Ms Tanya.”
“Sir, we live at the age of speed. Would you not agree?”
Mr Frik never likes to concede, and gives his favorite elusive answer: “I am not saying yes and I am not saying no.”
Tanya answers: “Fair enough. Let me illustrate. All systems have one constraint and the speed at which you go through the constraint per unit of time dictates your Throughput. So, in fact, Revenues are equal to the selling price divided by the speed at the constraint per unit of time. The Quantity variable is not as good a predictor of revenues as speed and value at the constraint are!”
Mr Frik is listening while searching the web on his phone. But one can tell that he is paying attention despite his laissez-faire demeanour.
Tanya presents this table, assuming that all requests for investigation are priced at the same amount and are indistinguishable from one to the next in terms of size, complexity or time to solve. She is right.
She points out that the additional Throughput rate at the constraint for Charles’ proposal is 0.16 (973/5840) requests per hour while hers is 0.25 (1460/5840), significantly more!
Mr Bounce interrupts after noticing Charles’ dubitative posture and says: “Tanya, we are CPU bound. Could you put your logic on equal footing with Charles’ and make your case on a similar table? That would make things easier for all of us.”
Tanya then presents her analysis comparing Charles’ proposal in one column and hers in the right column. She breaks down the value stream to show that the constraint is at the STOP phase where a request would spend five hours to be processed.
She indicates that any improvement that would not generate more Throughput would only increase layers of overhead costs and that her solution, despite adding one hour to both the CATCH and RELEASE phases, was beneficial. What counts is reducing the time spent at the constraint.
She then recycles Charles’ table to make her point:
Charles’ alternative is discarded and Tanya has to prepare the Financial reports. The increase in Operational Throughput of 292 requests per year (or 4.5 times more than Charles’ 65 additional requests) is palatable, but they still need to know what they’re in for. Mr Frik is still smiling. And every body at FAK CHEK knows what that means.
Mr Frik congratulates Tanya and tells Charles he will not be retained. He then asks Tanya to come up with a complete financial perspective now that he understands Operational Throughput. Still, he needs to see the other side of the coin - Financial Throughput - and a schedule to implement. He reminds her that once a project begins, the criteria for profitability are the projects’ duration and ROI over twelve months rolling calendar starting at the beginning of the development phase.
Tanya is told to contact the Board once the reporting is done.
Before seeing Tanya off, Mr Frik says: “I don’t know how you are going to get the Financials in order since you did not even bother to see our monthly cost function and allocation practices. So, before you call and ask me for the relevant information, I printed out the basic figures so that you don’t bug me later. I am a busy man.”
He hands the following data sheet to Tanya:
Tanya noticed that the information was about Operational Expenses and in French but that would not matter. What would ultimately count were the marginal impact of her analysis on TH, I, and OE. The following Throughput Accounting data is gathered for the project:
The Income Statement is ready in no time!
Tanya also prepares a Break-Even analysis to support the duration calculation (the period of the break-even point, which occurs when Net Profit reaches zero).
Days later, Mr Bounce, Frik and Tanya look at the proposal.
Tanya starts her presentation with the data above.
She explains that the project has a duration of six months and a Net Profit of $90,000 for the twelve rolling calendar months starting at the beginning of development.
Mr Frik says that he had hoped for Financials that were more in line with the best practices of the industry and that this worries him. The math does not add up. He shows her a set of Financials that would pass the smell test for any CPA. Hers will not.
“How could you, Tanya? How could you forget to deduct the salaries of the full-time employees from the project’s projection? They will be working on that project! And the Variable and Fixed overheads as well. And commissions! I have never seen in my lifetime a COGS section that was, well, not there at all! By COGS, I mean Costs of Goods Sold! I can’t accept this Net Profit of $90,000.”
He continues, “Let me show you an Income Statement like it should be done with our modus operandi. How can you expect our respect if you do not want to understand how we work and how we are financed?”
Tanya asks: “Would the numbers you’ve tallied be the same if they were done by another CFO?”
“Of course not. This is an art as much as a science. This is why we have a Handbook! Finding the right cost drivers to allocate expenses is simply impossible!”
“Exactly my point.” Tanya answers. “We are more concerned with data relevancy than data accuracy. And when the IFRS, FASB, FFRs, EITF guidance papers, ARBs and GAAP guidelines combined together take up more than 20,000 pages, I would choose another name than Handbook. Form is the least of our concerns, while for Financial Accounting, it is mandatory. We are worlds apart when discussing decision-making.”
When Mr Frik hears technical terms that could only be known to a CPA, he searches for her name on the AICPA member repertory. She’s on it! She’s one of ours! Not a good day to get a bloody nose. He changes tactics. His mission now is to extract her knowledge.
Tanya continues: “But Mr Frik, your technical points are right on the money. And I have prepared for you a bridge from your GAAP Income Statement to a Throughput Accounting Income Statement. See for yourself that the bottom lines balance. No spilled milk and no expenses have been omitted. This way of presenting data makes you focus on growth, not expenses. The more you see expenses, the more you are motivated to cut them. So, upon receiving your Throughput Accounting Income Statement, develop the following simple reflex:
Validate if TH is greater than OE
This will allow you to evaluate the consequences of increases in Throughput and decreases in pricing. You never want to decrease prices. Ever. But this is programmed into our DNA as CPA’s.”
Mr Frik is listening but knows he needs to get out of this meeting ASAP, while leaving the impression that he has the upper hand. “I see. The bridging algorithm is nothing short of clerical. Would you not agree, Tanya?”
“Absolutely. And understanding that, you have already figured out that you will not need two sets of books. This is an unfounded concern that ‘would be’ adopters of Throughput Accounting have. But I get the feeling that this ‘pricing across the board’ you’re practicing is a legacy of a bad habit this company has of covering costs that are unavoidable. In your case, I would strongly suggest you find a more diverse approach to pricing. For example, Throughput generators are the newest thing. There is also a great potential here to be more creative with pricing. And the sales force would love it as ‘one size fits all for pricing’ takes the wind out of all marketing efforts.”
Mr Frik understands that they should not focus only on operational issues but on sales strategies as well. He asks Tanya to take this extra dimension into account.
Tanya looks at Mr Bounce. “I need more money for that!”
“Write your own ticket and send me a proposal,” says Mr Frik. “And don’t forget the operational purchase discount.”
Tanya suspects something is amiss and is willing to engage. “What makes you think I would offer such a discount? You’d have to pay me upfront!”
“I know that, Tanya. I saw the depth of your bench at head office. It seemed pretty crowded to me! I want to help you manage your Inventory. Telling me that TVC do not exist in Knowledge-Work is one thing, but making me believe that Inventory does not apply is deceitful, would you not agree?”
“Bravo Monsieur Frik,” says Tanya. She’s surprised but she’s been here before. “Indeed, our fleet of consultants at head office - or the employees at your company - is our Inventory in Knowledge-Work. It is a novelty in the field of cash management that I will be happy to share. You have been busy reading.”
“I am not saying yes and I am not saying no,” Mr Frik replies, very seriously.
They both cannot stop laughing.
Improvement Initiatives that do not take into account the constraint of your system will increase layers of permanent costs, which in turn will cause your demise. Understanding the deltas is key in differentiating between green money and brown money. It is often not understood but I like the analogy made just above.
The Theory of Constraints, the five focusing steps and Throughput Accounting are also packaged together under another ToC term: POOGI – Process of On-Going Improvement.
It covers a wide array of topics that are beyond the scope of this article, the most fascinating of which is the bonus remuneration system to align motivation and behavior; a key tenet of management accounting and culture.
As humans we are creatures of habit. So, letting go of your favorite Continuous Improvement method is asking for too much as they all have merits. Just include the knowledge rendered in these lines and you should be able to do better at no extra cost.
Many people wonder if they must keep two sets of books to leverage Throughput Accounting. It is possible as reconciliation from any accounting system to another is straightforward. In truth, very few people keep two sets of books. It is best to keep your current systems to fulfil your Financial Statement reporting obligations under GAAP or IFRS. Those are the more complicated systems to maintain as they have a much more detailed level of granularity.
Migrating to a strict Throughput Accounting system would require adjusting your inventory accounts to tally the TVCs and the overheads separately. Much ado about nothing.
The preferred avenue is to stick to the Throughput Accounting Income Statement preparation only. Bridging to that statement from any other accounting system is quite easy as the only thing required is to remove the allocated overhead costs buried in your Inventory accounts and put them under (OE) - Operational Expenses at period end.
Next, assemble the relevant Throughput data at the constraint, and focus on mastery of the five focusing steps. Then comes the Throughput Accounting decision-making algorithm of delta (TH) Throughput, delta (I) - Inventory and delta (OE) – Operating Expenses in that precise order. Once you have that in hand, you’re ready!
There are many ToC metrics for manufacturing. For Knowledge-Work, visualization is king and it is sufficient to instrument both the Flow Efficiency and DBR boards interchangeably when context demands it. The flow metrics between process steps is more than enough. Removing column WIP limits is mandatory as it impacts flow.
I would suggest only one metric on top and above the ones that are intrinsic to your Flow Efficiency and DBR boards regarding Lead Times and in-process times. That one additional metric is to count the frequency of yellow, red and black signals from the DBR buffer. When they are too frequent, increase the buffer size. When you are not receiving any replenishment signal, it’s time to worry: you may have too much WIP in the system.
- 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/
 Green money is money that has been freshly introduced into the system – for example, through new sales. It can also be new money that must be found to meet unexpected expenses without taking sums from the current budget. That sort of money requires special approval to obtain or a procedure to follow that is more demanding than simply taking existing and planned-for money from your current budget and assigning it to meet another operational need. This lies within your span of control.
 Brown money is ‘familiar’ money. It can be the predictable sales revenues from your top 5 customers. Year in, year out, it is money assigned to your operating budget: keep-the-lights-on money! Some parts are discretionary and others non-discretionary. It is used at the operational level and if you deem that changing the labor mix or doing things differently will help Identify, Exploit or Subordinate to the constraint, then there is no ‘new’ money involved. You are within your span of control. The first three steps of the 5FS use that kind of money primarily. In line with the Five Focusing Steps, there is often no need to increase overall Investments or Operating Expenses to redirect money to the constraint by taking money that is used in vain away from the constraint. It can be a zero-sum game budget and spending wise. Brown money inflows refers to Improvement Initiatives that make you more efficient but do not bring in green money generated by new sales. Money ‘saved’ in operational ‘man days’ is often illusionary money that does not make it to the bottom line of the Income Statement. This is brown money as well.
 I am often reminded of the story of the $7,000 ‘cost per day’ of staying at the hospital. An Improvement Initiative of $1 million was approved to shave off the length of stays by 1,000 days annually. Someone got on the hook for $1 million as any changes one makes on how to make use of existing capacity that is already paid for never affects the bottom line. Of course, resource efficiency will most likely increase, but we all know what high resource efficiency does to flow efficiency! For a compelling story on that topic in the health care industry, read the article about the Ottawa hospital.
 Performing the first three steps of the Five Focusing Steps, while not impacting (OE) – Operating Expenses or (I) – Investments, is an example of using brown money. It has great value in this context.
 Du Plooy, Etienne. ‘Throughput Accounting Techniques’. General Media Press. 2016. Pages 57-63
 The concept of TVC – Totally Variable Costs seldom applies to Knowledge-Work
 Inventory at TVC in Knowledge-Work is a moot concept as far as Throughput Accounting is concerned. Capital asset projects – case in point - always include labor costs. In that regard, historical data regarding past projects are useless for decision making!
 This sentence is mine. Note that ROI and IRR are not additive, which makes the Throughput rate a fascinating tool to arbitrage and rank projects within a constrained system!
 Not only is the company fictitious but so is the story and the family names!
 CoD for Cost of Delay
 ToC for Theory of Constraints
 Pronounce ‘fric’ à la française. Fric means Money
 From Dave Snowden, 23 August 2021: “Mental models are not supported by cognitive neuroscience as they arise from a poor metaphor that does not understand the diversity of human decision making.”
 This quote is attributable John Maynard Keynes. It is used frequently within ToC circles.
 The Throughput rate is the speed at which you go through the constraint. Classical economics have us thinking in the of Price x Quantity to derive revenues. Throughput Accounting ascertains absolute profitability with the time that you mortgage the constraint per unit produced. The faster a product passes through the constraint, the better!
 Duration is the time it takes to break even.
 There are no predetermined formats to report Throughput Accounting data as opposed to Financial Accounting statements where form is important.
 This bridge appears in Appendix
 Throughput Accounting treats discounts differently. If they are of an operational nature for quick shipment to get cash immediately and inventory out the door, they are called purchase discounts. These discounts do not show on the Income Statement and are deducted from Net Sales. The other kind of discount is for quick financial settlement once the goods are received, they are commonly referred to as terms of payments. They are of a financial nature. They are accounted for under General Expenses after Net Profit and before EBITDA.
 This topic will have its own article.
 Culture is a reflection of our systems and our systems are a reflection of our culture. When in doubt, start with system changes by adopting Throughput Accounting. The results will come fast.
 Raw materials, Work In Progress and Finished goods.
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