theory of constraints
DESCRIPTION
TOC- summary of chapter 5TRANSCRIPT
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Welcome Group – ScarletGroup – Scarlet
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Group Members
• Sharmin Nahar 14054• Tanha Rashid 14062• Jumi Pal 14082• Shehrin Saleh 14085• Israt Zahan 14151
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THE THEORY OF CONSTRAINTS AND THROUGHPUT ACCOUNTING
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Constraint & its Strategic Implications:
• Constraint: Anything that limits an organization from moving toward or achieving its goal.
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Theory Of Constraint (TOC):
• A systems management philosophy Developed by Eliyahu Goldratt in the mid 1980’s with his business
• novel The Goal.
• Looks at the entire supply chain and synchronizes the chain to• achieve ultimate performance.
• Based on two assumptions: – Every organization has a set of processes working together to achieve
a common goal.– Every process has a [single] constraint that limits it from higher
performance
• Assumes current constraints cannot be changed in the short-run-What should be produced now, with current resources, to maximize
profits?
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Theory Of Constraint (TOC): is a way to manage constrained processes in order to maximize profits by increasing system throughput.
Throughput= Sales Revenue – Direct Materials
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Constraints & Quality, Cost & Time:
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Strategic Position of TOC:
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TOC linkage to product strategy:
• Step 1 :Product strategy defines the market segments The firm will sell in , the specific products to be produced for those markets and the profits expected.
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Product Concept and feasibility:
• Step- 2Translate product and profit plans into specific products concepts. Feasibility is determined by making preliminary estimates of life cycle costs, evaluating required investment in technology, training and estimating capacity needs.
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Product / process design and development:
• Step -3Detailed specifications for manufacturing and assembly are developed at this stage for physical goods.
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Production and logistics:
• Physical process of creating goods and services.
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• TOC at product development stages:Assures that daily activities produce the proper product and services to satisfy customer demand and profitability
• TOC at production stages:Provides information about managing capacity optimally.
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• Assure efficient use of existing capacity.
• Identifies processes that need immediate additional resources.
• Searches areas where customer are waiting ( bottlenecked area)
• Assist efficient production.
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Drums, buffers , ropes:
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Drums:
• Sets the pace of the work of the plant and is particularly useful for downstream operations (operations after the bottleneck) to help anticipate working process inventory output flow from the bottleneck.
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Buffers:
• A minimal of inventory kept in front of bottleneck keeps it running at full capacity.
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ROPES:
• Restraints the upstream operations (operations before the bottleneck) from overloading the bottleneck with too much work in process inventory input flow.
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Bank Load Process
•
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Production Data:
Work Center
Work description
1Assemble Case
2Insert board
3Insert Cards
4Mount Drives
5Check quality
Minutes per hour 60 60 60 60 60÷12 ÷ 8 ÷ 20 ÷ 16 ÷ 4
5 7.5 3.0 3.75 15 X 8 x 8 x 8 x 8 x 840 60 24 30 120
Minutes per unit
Units per hour
Production hour per day
Maximum Units per day
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TOC Management of Work processes
TOC Based Schedule 1 2 3 4 5
Balanced units per day 24 24 24 24 24
Capacity Used 60% 40% 100% 80% 20%
Work -in- progress inventory 0 3 0 0 0
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Developing a TOC Operation:
• TOC defines profit in terms of throughput. Organization using TOC will do three things to maximize throughput.
1) establish sales price > total variable costs2) focus on providing goods and services that have
the largest difference between totally variable cost and price.
3) minimize the time between spending money to produce and receiving money from selling goods and services.
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The Five-Step TOC Process
• Step 1. Identify the system's constraint(s).• Step 2. Decide how to exploit the system's
constraint(s).• Step 3. Subordinate everything else to the
above decision.• Step 4. Elevate the constraint(s).• Step 5. If a constraint has been broken, go
back to step 1.
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Constraints
Internal External
MaterialProcess Policy Market
Step-1 Identify the system’s constraints
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Process Constraints
• Occur when a given process or operation in the company has insufficient capacity to fully satisfy market demand.
• Example: Example: the loan officer is physically unable to perform the three steps on all loans requested in the allotted time.
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Policy Constraints:
• Occurs when management or employee unions enforce a rule that limits an organization’s operating abilities or restricts its flexibility.
• Example: Example: bank requires every loan to go through a formal process regardless of size, or nature of customer.
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EXTERNAL:
• Material constraints: occurs when outside source of material becomes restricted.
• ExampleExample: : the bank lacks sufficient load fund to satisfy the number of loans approved.
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• Market constraints:Market demand does not fully utilize a company's capacity to make the product.
• Example: Example: bank customers are not demeaning as many loans as the bank is able and willing to supply.
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Step-2: Decide how to exploit the systems constraints:
• Once a bottleneck is unidentified the organization must effectively maximize the money making capacity of the bottleneck by calculating the throughput yield per unit of constrained resources.
• Example: Example: Officer’s inability to process loan – Accountant could measure the loan revenue potential of each hour spent approving loans.
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Step-3 :Subordinate everything else to the preceding decision:
• Constraints other than exploited constraints are secondary. The goal is to coordinate production efforts at non-bottleneck operations to keep the constraints operating at optimal capacity.
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Step-4: Elevate the constraints:
• Involve offloading some of the processing work to non-bottleneck operation despite their less efficient product capability.
• Example: Example: in the loan approval process assign much of the packet assembly and credit check work to less experienced bankers.
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Step-5 • If a constraint is broken go back to step 1• In this step, the objective is to ensure that the Five Focusing
Steps are not implemented as a one-off improvement project. Instead, they should be implemented as a continuous improvement process.
• If the constraint has been broken (the normal case), recognize that there is a new constraint. Finding and eliminating the new constraint is the new priority (restart at Step One).
• If the constraint has not been broken, recognize that more work is required, and a fresh look needs to be taken, including verifying that the constraint has been correctly identified (restart at Step One).
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The Process in short:
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A comparison of Throughput and traditional accounting systems
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Comparing Three Profit and Loss statement
GAAP Basis CM Basis Throughput Basis
Revenue $500000COGS (120000)
Gross Margin $380000
Selling and Gen. admin expenses (350000)
Operating Income $30000
Revenue $ 500000Variable costs (155000)
Contribution Margin $345000
Fixed Costs (315000)
Operating Income $30000
Revenue $ 500000Direct materials (50000)
Throughput Margin $ 450000
Operating expense (42000)
Operating Income $30000
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Inventory Effects of GAAP versus Throughput Accounting
Assumptions: Sales price is $5,000 per ton; Materials costs are $500 per ton, Conversion costs (labor andmanufacturing overhead are $70,000 per period
GAAP Basis Throughput Basis
Scenario 1:Productionequals sales
Scenario 2:BuildInventory
Scenario 3:ShrinkInventory
Scenario 1:Productionequals sales
Scenario 2:BuildInventory
Scenario 3:ShrinkInventory
Sales 100 tons 100 tons 100 tons 100 tons 100 tons 100 tonsProduction 100 tons 110 tons 90 tons 100 tons 110 tons 90 tonsRevenue $500,000 $500,000 $500,000 $500,000 $500,000 $500,000Expenses: Materials 50,000
a 50,000
a 50,000
a 50,000
b 55,000
c 45,000
d
Conversion 70,000 e
63,636 f
77,778 g
70,000 h
70,000 h
70,000 h
Sell. & Gen. Admin. Exp. 350,000 350,000 350,000 350,000 350,000 350,000 Operating Income $ 30,000 $ 36,364 $ 22,222 $ 30,000 $ 25,000 $ 35,000
Calculations:a 100 tons sold x $500 per ton e
100 tons sold x ($70,000 100 tons produced ) b 100 tons produced x $500 per ton f
100 tons sold x ($70,000 110 tons produced)c
110 tons produced x $500 per ton g 100 tons sold x ($70,000 90 tons produced)
d 90 tons produced x $500 per ton
h Assumed fixed in the short run at $70,000 per period
___________ ___________ ___________ ___________ ___________ ___________
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Attributes of Throughput Accounting:
• Technical Attributes: By enhancing process understanding within
the organization, TOC and throughput accounting provide information that is relevant to making good decisions.
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• Decision RelevanceMuch of the management focus in a TOC operation is on the bottleneck. Because f its central importance to the organization’s capacity to make money, the bottleneck must necessarily receive the lion’s share of management attention.
Managerial accounting plays an important part in the management of bottlenecks by
– improving capacity use – avoiding inventory buildup.
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• Throughput accounting is not a cost system– The full costs of production are not assigned to
products– Does not integrate with the general ledger
• Most organizations need more than one accounting system, some traditional costing System like ABC.
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• Process Understanding :TOC required a through understanding of work processes, the flow of product from one operation to another and capacity & throughput time of each. It provides a financial system wise view of the organization.
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Behavioral Attributes:
• Whenever information systems change and mgt introduces new performance measurement, behaviors are affected.
• Benefits:– Avoids local optimization: encourages cooperation
through the organization to achieve company profit goals instead of rewarding for optimization of individual process.
– Improved Communication between departments
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Cultural Attributes
Creating and receptive culture for TOC: Introducing a new process in an existing
organizational culture is always hard. People have their existing beliefs, values and mindsets. Mgt. should use training, speeches, and internal literature to demonstrate the impact of TOC on a business unit or product line.
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• Mindset change: Making the shift to a TOC based operation often requires that management make significant mindset adjustments. Unlike traditional system, TOC the focus is on producing what customers want instead of the maximum output.
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Assumptions versus The Facts:Prior Assumption Current Fact
Keeping people busy is the key to making money. A focus on labor utilization hinders cash flow due
to high inventory and the emphasis on keeping
people busy.
By keeping utilization high, employees help the
company perform well financially.
High utilization of resources does not correlate to
profitability.
High labor-utilization rates ensure high levels of
customer satisfaction.
High utilization of resources does not necessarily
correlate to high customer satisfaction.
If managers release workers to other areas of the
operation, they may not get them back when they
need them.
Managers will willingly release workers to go
where the work is when right performance
measures are used.
Traditional accounting standards tell managers
whether they are effective as a total enterprise.
Traditional standards are subjective, inaccurate,
and require constant monitoring.
Maximizing the production output per setup and
building inventory is key to making money.
Making only what customers order is the key to
making money, and on-time delivery is the critical
success factor.
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• Creating cross-functional cooperation:• TOC implementation requires cooperation
across functions and processes in an organization.
• Information has to be shared on customers’ want and on the availability of the capacity.
• Teamwork must be the norm. • Everyone must work on elevating the constraint.• Non- constrained operations must subordinate their
needs to needs of the constraint.
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Thank YouThank You