Throughput accounting

1 Introduction

Key factor analysis deals with the situation where several products are being made but where there are limited resources available.

In this chapter we will look at key factor analysis first, and then explain how this may be adapted in a modern environment to perhaps a more meaningful approach known as throughput accounting.

2 Key Factor Analysis

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In a situation where we are manufacturing several products, all of which use the same limited resource, then we need to decide on how best to use the limited resource in production.

The standard key factor approach is to rank the products on the basis of the contribution earned per unit of the limited resources.

Pi plc manufactures 2 products, A and B.

The cost cards are as follows:

	A		B
Selling price	25		28
Materials	8		20
Labour	5		2
Other variable costs	7		2
Fixed costs	3		2
	23		26
Profit	$2		$2
Machine hours p.u.	2 hrs		1 hr
Maximum demand	20,000	units	10,000	units

The total hours available are 48,000.

Calculate the optimum production plan and the maximum profit using conventional key factor analysis

Answer to example 1

	A	B
Selling price	25	28
Materials	8	20
Other variable	12	4
	20	24
Contribution p.u.	5	4
Machine hrs p.u.	2	1

Contribution per hour	$2.50	$4

Production

	units	hours
B:	10,000 × 1 hr =	10,000
A:	19,000 × 2hrs =	38,000
		48,000	hours

Profit

		$
A:	19,000 × $5	95,000
B:	10,000 × $4	40,000
		135,000
less	Fixed costs:
	[A: 20,000 × $3
	B: 10,000 × $2]	80,000
	Profit	$55,000

3 Throughput Accounting

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The key factor approach described in the previous section is very sensible, and the throughput approach is effectively the same. However, there are two main concepts of throughput accounting which result in us amending the approach.

3.1 The main concepts of throughput accounting are:

in the short run, all costs in the factory are likely to be fixed with the exception of materials costs
in a JIT environment then we should be attempting to eliminate inventories. Use of a limited resource in production of inventories should be avoided and therefore any work-in-progress should be valued at only the material cost

4 Definitions:

Throughput = sales revenue – material cost
Total factory costs = all production costs except materials

Return per factory hour

Cost per factory hour

Throughput accounting ratio

4.1 Target for decision making:

The TA ratio should be greater than 1 if a product is to be viable. Priority should be given to those products which generate the highest TA ratios.

Pi plc manufactures 2 products, A and B.

The cost cards are as follows:

	A		B
Selling price	25		28
Materials	8		20
Labour	5		2
Other variable costs	7		2
Fixed costs	3		2
	23		26
Profit	$2		$2
Machine hours p.u.	2 hrs		1 hr
Maximum demand	20,000	units	10,000	units

The total hours available are 48,000.

Calculate the optimum production plan and the maximum profit, on the assumption that in the short-term only material costs are variable i.e. using a throughput accounting approach
Calculate the Throughput Accounting ratios

Answer to example 2

	A	B
Selling price	25	28
Materials	8	20
Throughput p.u.	$17	$8
Machine hrs p.u.	2	1

Contribution per hour	$8.50	$8
	(2)	(1)

Production

	units	hours
A:	20,000 × 2hrs =	40,000
B:	8,000 × 1hr =	8,000
		48,000	hours

Profit

		$
A:	20,000 × $17	340,000
B:	8,000 × $8	64,000
		404,000
less	“fixed” costs:
	[A: 20,000 × $15
	B: 10,000 × $6]	360,000
	Profit	$44,000

Cost per factory hour = 360,000 ÷ 48,000 hours = $7.50

Throughput accounting ratios:

A: 8.50 ÷ 7.50 = 1.13

B: 8 ÷ 7.50 = 1.07

5 Bottleneck Resource

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In practice, it is likely that a product will have to be worked on by several machines - one after the other.

The rate of production will be restricted by the slowest of the machines, and this machine is known as the bottleneck resource.

The calculations that we have been through in the earlier examples will be performed using the hours per unit in this bottleneck resource.

Work the bottleneck out rather than reading it off. Divide each process’s total hours by the time one unit takes there; the process with the lowest maximum output is the constraint. It is not necessarily the one with the fewest hours available, nor the one with the longest time per unit.

Yam Co is involved in the processing of sheet metal into products A, B and C using three processes, pressing, stretching and rolling.

The factory has 50 production lines each of which contain the three processes: Raw material for the sheet metal is first pressed then stretched and finally rolled. The processing capacity varies for each process and the factory manager has provided the following data:

	Processing time per metre in hours
	Product A	Product B	Product C
Pressing	0.5	0.5	0.4
Stretching	0.25	0.4	0.25
Rolling	0.4	0.25	0.25

The factory operates for 225,000 hours.

Identify the bottleneck process and explain why this process is described as a ‘bottleneck’.

Answer to example 3

The total processing hours of the factory is 225,000 hours.

Given this, the production capacity for pressing must be 225,000 hours/0·5 hours per metre = 450,000 metres. Using this method the production capacity for all processes is as follows:

	Product A	Product B	Product C
Pressing	450,000	450,000	562,500
Stretching	900,000	562,500	900,000
Rolling	562,500	900,000	900,000

The bottleneck is clearly the pressing process which has a lower capacity for each product. The other processes will probably be slowed to ensure smooth processing.

Clearly an alternative approach is simply to look at the original table for processing speed and pick out the slowest process. This is pressing.

Answer the questions one at a time. Your progress is saved so you can leave and come back.

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