We are continuing our series based on The Goal by Eliyahu M Goldratt.
The core idea in the Theory of Constraints (TOC) is that every real system, such as a for-profit business, must have at least one constraint. If it were not true, then the system would produce an infinite amount of net profit. Because a constraint is a factor that limits the system from getting more net profit, then a business manager who wants more net profit must manage constraints. The constraints will determine the output of the system whether they are acknowledged and managed or not.
Dr. Goldratt says it this way: “Before we can deal with the improvement of any section of a system, we must first define the system’s global goal; and the measurements that will enable us to judge the impact of any subsystem and any local decision on this global goal”.
It is impossible to disentangle using TOC in operations (DBR) from TOC accounting (known as “Throughput Accounting”). Any attempt to run TOC in operations while using traditional management accounting measures and controls is doomed to failure. TOC is a radically different way to control operations and does not work with conventional cost accounting systems.
As an alternative, TOC and Throughput Accounting introduce three measurements for increasing net profit:
1. increase Throughput (Sales minus truly variable costs such as raw materials),
2. decrease Operating Expenses (that is, fixed costs), or
3. decrease Investment, particularly in inventories.
To make decisions according to TOC, we need to quantify the decision’s impact on these three measurements and then we will be able to determine the change in net profit and return on investment.
…to be continued.
Here’s to maximizing YOUR profits!
Dr Lisa Lang