TOC-L/Goldratt/CMSIG Postings
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Constraint Accounting Measurements TOC-L/Goldratt/CMSIG Postings |
97-04-29 thacker.heath.hw@bhp.com.au (Thacker, Heath HW)
I'm particularly interested in this topic, as I'm contantly frustrated by the short comings of Cost Accounting.ELI Asked [see discussion of Constraints Accounting]: What about scrapped materials? If the current technology is so that 75% of raw materials is lost - should not we include it in the T calculation?
RUDI Answered: YES it should be included. Everyone will know/see that losing 75% of raw materials is a constraint to more Throughput. What needs to be known is: Is it a fact of life, or can we do something about it? The question needs to be posed again and again.
I would have thought that this scrap loss would only have been included in the calculation if it was after the constraint. Any scrap loss before the constraint has no effect on the throughput of the system, (as long as the constraint is not "Starved of work"). This scrap loss, before the constraint, only effect is to increase OE, without impacting on throughput.
97-04-30 jonalisa@chesapeak.com (Lisa Scheinkopf)
I, too, am not convinced that Rudi's emphatic YES! is the answer, every time, to this question.When it comes to scrapped materials, the value of the scrapped materials (purchase price from vendor) will be either deducted from sales to calculate throughput, or will be considered as operating expense.
In either case, the net profit of the company is the same. So, the question is, what would be the reasoning of a company to calculate the scrap one way versus the other?
I believe this brings us back to the role of measures as influencers of actions taken and decisions made by people. I'll throw out a few questions, which will, perhaps, spark some thinking:
1) What about the situation in which the amount of scrap is a function of how products are grouped (batched) together in order to produce them? Such as wood, food, and apparel products. I haven't found a place yet where scrap is exactly the same amount whether you make a single unit or 100 units, for instance, of the same product.
2) In the case of the company who's current technology produces only a 75% yield, can we say that the 25% of the stuff that's thrown away is "money the system spent on turning inventory into throughput?"
3) Let's say that we do subtract somehow the value of the scrapped materials from the selling price of the product to calculate throughput. Now, let's say that our company produces and sells three products. Product A has a T/Cu of $100, Product B has a T/Cu of $125, and Product C has a T/Cu of $150. And, let's say that we're in a "sold out" position, with more market available for all three products. We would naturally go tell our sales and marketing folks to please sell more of Product C, at the expense of products A and B, correct? Well, what if I told you that the reason Product A has a T/Cu of $100 is that because of the way the product is made, we scrap some material. If we reduced that scrap by 50%, we'd end up with a T/Cu of $200! Please, don't tell me that we should then simply institute some sort of way in which to analyze very product to reaaallllly understand it's throughput. It's not at all that simple, particularly as we bring this example to the real world of most companies, who sell hundreds if not thousands of products. I want a measure that I can look at, believe it reflects reality, and have some guidance on what to do!
When I first learned this stuff ten years ago, it was almost beaten into me that when we're talking about the totally variable costs that participate in the throughput calculation, we're talking about totally variable to the unit of sale. If it's not totally variable to the unit of sale, it's an operating expense.
Through the years, even to this day, I continue to learn how deep the cost world is in my bones. There are two areas specifically that I have to actively remind myself to pay attention to, lest inertia get the best of me:
1) Operating Expense is NOT simply another way of saying "fixed costs". Yes, your fixed costs are operating expenses. But, most of those things that you consider to be "variable" are also operating expenses. The words that Eli chose to define throughput (The RATE at which the system generates money through sales" and operating expense ("All the money the system spends to turn inventory into throughput.") The only "inventory" that turns into throughput is that "inventory" that your customer is paying you for. Usually, it's the "inventory" your customer sees. Not the inventory you have thrown away.
2) Beware the tendency to focus on "product" at the expense of "rate of money generation over a time horizon."
I've been pondering this subject for some time now. I am beginning to conclude that the answer is the famous, "it depends." It depends on what and who you're trying to measure, and the scope of the decisions that you're trying to make over the time horizon of your choosing. Last question:
Is it necessary that a company must decide BETWEEN using the scrap in the throughput calculation and placing the scrap in operation expense? Must this be an either/or?
97-05-02 elyakim@netvision.net.il (Eli S)
Lisa's recent post about TOC accounting well expressed the dilemmas of whether to include the scrap in the throughput calculation or in the operating expenses. She ends her analysis with a question "Must it be either/or?". I agree. It doesn't need to be either/or - but, every company for which scrap is significant needs to establish a procedure. When scrap is not significant - put it in the operating expenses because it is easier to handle and in line with the formal definition.However, when scrap is significant - where do we include it may impact our decision making. Lisa has mentioned that in most cases the amount of scrap depends on the batching; in other words on the operational policies. That's mean - scrap is not a truly variable expenses for a single unit of sale. Here I somewhat differ. The batching policies should consider lead-time and its impact on the market demand. Once a batching policy is implemented many daily decisions are taken that do not consider the batching policy. These decision only focus whether to sell (produce) a specific order. For such a decision - we may say that scrap is actually a truly variable expense per unit of sale! And when we do consider changing the batching policy - would we do a better calculation when we treat scrap as OE or as T? At least for TOC people dealing with improving T is their focus - and cutting down scrap, when it is significant, is really an improvement of the total T. This is because if you do two separate actions - increase sales and cut the scrap ratio - the improvement on the bottom line is multiplied.
Is it an either/or decision? Not necessarily. A possible way is to assign a minimum ratio of scrap, that is a realistic target for reducing scrap, to the throughput and add all the higher actual scrap to the OE.
A remark to Heath Thacker. The question whether the scrapped materials are part of a sale (hence - throughput) or operating expenses has nothing to do with the impact of the scrap on the capacity constraint. You are right in saying that when parts, already processed by the constraint, are scrapped - the exploitation of the constraint is going down, the result of which will be lower total throughput. This is an indirect impact - even though it is very significant.
97-05-02 npiinfo@cis.co.za (Etienne du Plooy)
In connection with the debate about scrap in a throughput accounting application, what is scrap and what is not scrap must be clearly defined."Losing" raw material in the manufacturing process was mentioned by ELI S.Is scrap product wasted, or is scrap material unused in the manufacturing process is the question I ask repeatedly. If scrap is product wasted and it was identified before or after the constraint it will reduce T because it reduces sales because it is not sellable. On the other hand, is scrap is material unused, then the cost thereof should be included in TVC to calculate T as the existence thereof is inevitable.
When scrap defined as product wasted happens before or after the constraint in a TA application it is the most expensive thing an enterprise can make because you loose TVC, OE and NP.
I thus see 2 types of scrap - one is avoidable and the other is not.
97-05-05 fpatrick@eclipse.net (Francis S. (Frank) Patrick)
In the recent conversation on accounting for scrap, Eli S wrote:Is it an either/or decision? Not necessarily. A possible way is to assign a minimum ratio of scrap, that is a realistic target for reducing scrap, to the throughput and add all the higher actual scrap to the OE.
This sounds very much like how scrap was handled at a food processing firm I worked for. This was a very-high volume producer of cookies (biscuits for you folks across the pond) and crackers. The standard plan for a particular product included an expected about of what we called B&R (broken and rejected). Then depending upon to what extent the cookies crumbled, the number that was, I believe validly, watched like a hawk was "Excess B&R."
To me the "Standard B&R" feels like part of the raw materials that goes into throughput, while the "Excess B&R" feels like OE. But that also points out that just because it's OE doesn't mean it's not a righteous target for improvement.
One of the interesting side effects in the system I described was to avoid sending all the B&R out to pig farmers, many of the recipes actually utilized a recycled portion of B&R. If the B&R rate went too far below the planned "standard," guess what they had to do. Yup...create some B&R.
97-05-08 jeaster@verinet.com (James E Easter)
I have worked in some environments where we had a budget for waste-composed of 2 parts: structural and incident.Structural waste was that waste which was created due to the design of the system (it was a chemical process line)--so the length of pipes literally caused "X" amount of waste everytime they had to be flushed, etc.
We also budgeted for incident waste-which was waste due to errors, etc.
Due to some pressure from an unnamed source (ahem!)--we eventually stopped budgeting for incident waste---and began to be accountable for all incidents-and guess what? Incident waste began to decrease (below what was formerly the best ever amounts)-----
This sounded similar to your "avoidable" and "unavoidable" waste below---
Our big learning is that all waste--whether avoidable or not reduces net profit---and should not be "forgiven"--not that we blame people-but we look to the system to tell us why it is occurring and look for ways to eliminate it-even our structural waste was dramatically changed as a result (it went down).
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