One of the other key
things I learned by reading The Goal
was the whole idea of Throughput
Accounting (TA). I had never been
introduced to TA so it was an eye-opening experience for me. Actually, I had never been responsible for a
company’s financials before and had difficulty understanding some of the
“rules” of cost accounting. I was being
held accountable to traditional cost accounting and quite frankly some of the
rules made no sense at all to me so I was questioning things. For example, how could excess inventory be
viewed as an asset? Isn’t inventory
tying up cash? And as I explained earlier,
running all process steps to the maximum capacity only served to drive
Work-In-Process (WIP) inventory higher.
And since we had discovered that there was a direct correlation between
having excess WIP and elongated cycle times, it made no sense to do so. But those were the rules of engagement that I
was being judged on.
When I read The Goal, I had an epiphany of
sorts. Goldratt introduced the world
to a new way of looking at profitability through a completely different financial
spectrum. While Cost Accounting preaches
their sermon of profitability through saving
money, Goldratt argued that rather than focusing on saving money, companies
should be focused on trying to make money,
and as I would soon discover, the two approaches are drastically different!
One of the principle
lessons within The Goal is that the
goal of for-profit companies is to make money now and in the future. Goldratt analogized that just like a chain
having a weakest link, so too does a company have a weakest link. And this weakest link controls how much money
a company will ultimately make. Goldratt
also explained that attempts to strengthen any other part of the chain (or
company) will do nothing to drive profitability higher. From an organizational perspective, this
simply means that every decision or action taken must be considered based upon
its impact on the goal of making money.
If the action or decision doesn’t get you closer to your goal of making
money, then don’t take that action.
Goldratt further explained that if you want to know if you’re moving in
the right direction in terms of profitability, you should ask yourself three
simple questions:
- Does your action or decision result in more Throughput (T)?
- Does your action or decision result in more Inventory ( I )?
- Does your action or decision result in more Operating Expense (OE)?
If you answered yes to
the first question, then it’s a good action or decision. If you answered yes to either question two or
three, then it might not be a good thing to do.
The optimum conditions for
maximizing profitability are to have T increasing while I and OE are
decreasing. Notice I used the word
“optimum” in terms of maximizing profitability.
It is certainly plausible to have OE increasing to drive T higher, it
just won’t result in optimum profitability.
Let’s take a look at the definitions of these three components of
profitability.
- Throughput (T): The rate that the organization
generates new money primarily through sales. Goldratt provided this formula for T:
T = R - TVC
TVC includes things that vary with the sale of a single unit of product such as the cost of raw materials, sales commissions, shipping costs, etc.
Inventory ( I ): The money that an organization invests in items that it intends to sell. This category would include inventory of all kinds.
Operating Expense (OE): The money an organization spends to turn ( I ) into (T) which includes ALL labor costs, office supplies, employee benefits, utility bills, etc
Goldratt further
expanded his Throughput Accounting (TA) definitions still further by defining
net profit, return on investment, productivity and inventory turns and he based
them all on the three simple measures T, I and OE. So, with these simple definitions, our team
was able to not only take actions and make decisions, but we were sure they
would positively impact our bottom line.
Here are Goldratt’s other definitions:
- Net Profit (NP) equals
Throughput minus Operating Expense or NP – T – OE
- Return on
Investment (ROI) equals T minus OE divided by I or ROI = T-OE/I
- Productivity (P) equals T
divided by OE or T/OE
- Inventory Turns (IT) equals T
divided by I or T/I
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