If you knew accurately what is actually making money in your company wouldn’t that then influence all your decisions regarding cost and investment? Well, isn’t that what accounting is for? The problem is, traditional accounting fails to give a complete and correct picture of what is happening dynamically.
Every company is trying to achieve a goal. Sometimes that goal is less clear than others, but generally speaking, people are aware that there is an economic point to what they are doing. As that is the case, they also need to know how to make the right decisions about where to spend money and how much activities etc. are costing. For this purpose most companies rely on cost accounting.
But what if the measurement system is not usefully designed to support decision-making? We will create wrong policies. By subordinating to wrong policies, we can actually damage the results of the organization.
You need to know your constraint
Every organization is a dynamical system and every system has a constraint, whether they know it or not. The constraint exists, and ideally we choose strategically where it is.
It turns out that the ability of any organization to achieve its goal is limited by a very small number of factors, indeed we can say it is limited by only one: the constraint. This knowledge about the constraint gives us a critical advantage:
The constraint determines the pace at which the system generates units of the goal, that is, the throughput of the system.
In for-profit companies, the units of its goal are linked to the generation of monetary profit. So if the constraint determines the pace of throughput we need to know exactly how everything happening in the company impacts the constraint.
Radical simplicity in complexity
How can we most effectively manage complexity? By anchoring our organization/system to one point, the constraint. By understand ing interdependencies (the actual forces in a dynamical system) we can manage and lead the organization toward maximizing throughput (value). This corresponds, in dynamics, to the path of least resistance.
Traditional accounting methods will not help us with this, indeed they are blind to it. So what can we do? The good news is you don’t need to be a math genius like Ben Affleck in his movie ‘The Accountant’. What is required for a truly accurate picture of what is going on in the company is Throughput Accounting from the Theory of Constraints. By adopting throughput accounting, we gain a much more accurate, and systemic picture of what is really happening in our company in terms of money in and money out. It also provides us with a much more accurate idea of the real profitability of any goods or services that we sell because it relates it the constraint of the organization.
Of course, when we adopt throughput accounting we cannot abandon tax, legal, financial, and general regulations and requirements that are mandatory in any country. On the contrary, we will have to use them alongside throughput accounting measurements.
In the next post we’ll take a look at the basic indicators in Throughput Accounting. Get ready for something radically simple and that -wait for it -makes complete sense.
(Apologies for the brief hiatus in this blog due to extreme jet lag but at least the trip provided an opportunity to see Ben Affleck in ‘The Accountant’ on the plane!)
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About the Author
Angela Montgomery Ph.D. is Partner and Co-founder of Intelligent Management and author of the business novel+ website The Human Constraint . This downloadable novel uses narrative to look at how the Deming approach and the Theory of Constraints can create the organization of the future, based on collaboration, network and social innovation. She is co-author with Dr. Domenico Lepore, founder, and Dr. Giovanni Siepe of ‘Quality, Involvement, Flow: The Systemic Organization’ from CRC Press, New York.