Theory of Constraints Handbook - James Cox Iii [247]
Advantages and Disadvantages of Traditional Budgets
Advantages of budget preparation include the following:
Planning for future periods is required.
Budgets facilitate communication throughout an organization.
Goals (expectations) are set.
All areas of the organization have input into the process.
Upcoming creditor covenants can be met or renegotiated.
Resource requirements can be established (Hilton, 2009, 348–349; Garrison et al., 2010, 369).
Disadvantages of the budgeting process and its uses are that it:
Sets an upper bound on performance (diminished incentive to “outperform” the budget);
Encourages padding of requests (gaming) in anticipation of forced reductions;
Results in a lack of budget ownership (budget numbers frequently are dictated by upper-level management);
Encourages competition between areas for resources;
Can encourage dysfunctional behavior in order to meet budget amounts;
Is cumbersome and too expensive (Cunningham and Fiume, 2003, 133–139; Hope and Fraser, 2003, Chapter 1; Hilton, 2009, 375–376).
TOC Approach to Planning, Control, and Sensitivity Analysis
As amazing as it may sound, TOC makes the strong assertion that all the allocation gyrations of traditional and newer accounting methodologies are not necessary and generally serve to confuse and obfuscate rather than enlighten. In fact, implementing TOC (or any other management improvement initiative) without changing the internal accounting and reporting system will send mixed messages to the troops and eventually, by encouraging people to go back to old and out-of-date policies and assumptions upon which previous reporting is based, will undermine the new system.
Planning
At its most basic level, planning includes establishing strategy and then implementing the chosen strategy. Because this subject is treated in detail in later chapters in this Handbook (Chapters 15, 18, 19, and 34), treatment of strategy and tactics are deferred until later.
The typical starting point for planning in a Throughput environment is recognition of the organization’s most binding constraint (Step 1 in TOC’s Five Focusing Step [5FS]-process). If raw materials are in short supply, vendors may occupy this position. Most often, though, an organization’s demand from its customers poses the most binding constraint, especially in times of recession in the economy as experienced in the last half of 2008 and in 2009. Because of company policies, however, it is not unusual also to find one or multiple internal constraints.
Finding the Best Product Mix
Accounting people typically think about capacity in terms of facility capacity, not the capacities of individual resources used to produce a company’s products. If demand is greater than any one of an organization’s resource capacities, however, products must be prioritized.
The traditional approach is to prioritize products based on one of the following: (1) selling price, (2) gross profit, or (3) contribution (gross) margin. An activity-based accounting system prioritizes products based on activity-based gross profit for each product.
TA uses explicit recognition of an internal constraint when prioritizing products. One of the most familiar TOC formulas used to determine the best product mix when demand is greater than production capability (an internal constraint exists) is throughput per unit of constraint time. Accountants will have learned this concept under the name contribution margin per unit of constraint, which is recommended to determine product priorities when an organization faces a single constraint.17 This process most easily is illustrated with an example.
Figure 13-1 is adapted from the original “P-Q” example developed and presented by Eli Goldratt in numerous workshops all over the world and in one of his