What is Throughput Accounting?
Throughput accounting is a process used in management accounting that focuses on a company’s production efficiency. It looks at the rate at which a company converts its raw materials into finished goods and makes money from them. The purpose of throughput accounting is to identify any bottlenecks in a production process. This process allows companies to either eliminate those bottlenecks or use them as efficiently as possible.
Throughput accounting aims to maximize a company’s profitability while also reducing its operating costs and inventory. It does so by evaluating which factors contribute to a stoppage or act as a bottleneck in the production process. Through this, throughput accounting identifies any factors that prevent a company’s throughput from being higher.
Throughput accounting is a method commonly used in Just-In-Time (JIT) systems. In these systems, any stoppage or bottlenecks can significantly increase costs or cause losses. For companies, it may not be possible to eliminate those bottlenecks every time. Therefore, throughput accounting focuses on the efficient use of limited resources to maximize throughput.
How Does Throughput Accounting Work?
Throughput accounting works by identifying any bottlenecks that may exist in a system. By doing so, it allows a company to understand its restraints and how they limit production. After identifying these, companies can decide on how to exploit those limited resources. This process requires companies to consider which products or processes can maximize profits.
Once companies identify the best use of their resources to maximize profitability, they can structure the process around the decision. In this process, companies can allocate the maximum use of any limited resources to the process with the highest profit contribution. Similarly, it requires them to provide the bare minimum resources for other processes to function.
However, throughput accounting may not end there. This process is continuous for most companies. By efficiently allocating one resource, companies may come across other bottlenecks. Similarly, two or more resources may contribute to stoppages to a process at the same time. Companies need to identify these and repeat the same steps as above continuously.
The throughput formula for a specific product is as follows.
Throughput = Sale revenue from the product – Direct material costs
What is the Throughput Accounting Ratio (TPAR) and How to Calculate It?
The throughput accounting ratio is a metric often used in throughput accounting. This ratio looks at the return a company generates for each hour of work compared to its costs for the same time. Through the throughput accounting ratio, companies can determine the rate at which they are making income from selling their products.
The formula below is used to calculate the throughput accounting ratio is as below.
Throughput Accounting Ratio (TPAR) = Return per factory hour / Cost per factory hour
The throughput accounting ratio requires calculating two figures. As mentioned, these are the return per factory hour and the cost per factory hour. The formula to calculate the return per factory hour is as follows.
Return per factory hour = Throughput per unit / Product’s time taken for the limited resource
On the other hand, the formula to calculate the cost per factory hour is as below.
Cost per factory hour = Total factory cost / Total limited resource time available
When a company’s throughput accounting ratio is 1, it means that the company generates the same return as it incurs costs. However, companies prefer for the ratio to be greater than 1. The higher the ratio is for a company, the better. It signifies that the company is generating more income than its costs for a unit of factor hour.
When a company’s throughput accounting ratio is greater than 1, meaning that its throughput is profitable. In that case, it is beneficial for the company to continue with the process as it will help cover the fixed costs while also making profits. A TPAR ratio of below 1, on the other hand, means that the company cannot recover its fixed costs from the throughput.
Example
A company, ABC Ltd., produces a product that has a selling price of $50. The direct material cost for each product manufactured is $20. Each unit of product manufactured takes two factory hours to produce. ABC Co. has a limited amount of factory hours for production, which is only 10,000 hours. ABC Co.’s operating expenses for each month is $100,000.
Before assessing the throughput accounting ratio, it is crucial to calculate the product’s throughput.
Throughput = Sale revenue from the product – Direct material costs
Throughput = $50 – $20
Therefore, Throughput = $30
Then is necessary to calculate the return per factory hour, which is as follows.
Return per factory hour = Throughput per unit / Product’s time taken for the limited resource
Return per factory hour = $30 / 2
Therefore, Return per factory hour = $15/hour
Lastly, it is critical to calculating the cost per factory hour.
Cost per factory hour = Total factory cost / Total limited resource time available
Cost per factory hour = $100,000 / 10,000 hours
Therefore, Cost per factory hour = $10/hour
Now, we can calculate the throughput accounting ratio as follows.
Throughput Accounting Ratio (TPAR) = Return per factory hour / Cost per factory hour
Throughput Accounting Ratio = $15 per hour / $10 hour
Therefore, Throughput Accounting Ratio = 1.5
Therefore, producing the product will be overall profitable.
Conclusion
Throughput accounting is a process companies use to maximize profitability and reduce costs when there are bottlenecks involved. The throughput accounting ratio looks at the returns from a product in comparison to its costs. Companies prefer products that have a throughput accounting of above 1.
