Lean Accounting vs Throughput Accounting: A Strategic Shift from Cost Reduction to Profit Maximization

The recent discussion about Lean Accounting has resurfaced my concern about using it in a North American business environment where leadership focuses on improving profitability rather than reducing costs. Today's most damaging paradigm in business is that cost-cutting leads to increased profits. This is why I have always advocated Throughput Accounting over Lean Accounting.

Lean Accounting’s Focus on Cost Reduction

Lean Accounting is designed to support lean manufacturing principles, which revolve around the elimination of waste (muda) and continuous improvement. While Lean Accounting aligns with operational efficiency and value stream analysis, it still inherently focuses on cost reduction in various forms:

• Waste Elimination: Lean principles aim to reduce or eliminate non-value-adding activities, often framed in terms of reducing costs.
• Efficiency Improvement: Streamlining processes to achieve flow efficiency typically results in lower production costs.
• Inventory Management: Reducing inventory levels is viewed as a cost-saving measure, as excess inventory is seen as a waste.
• Simplified Reporting: By focusing on value streams and eliminating complex cost allocations, Lean Accounting makes it easier to spot and reduce overheads, driving cost reduction decisions.

The mindset in Lean Accounting tends to be operationally focused, with an eye on reducing costs to improve profitability. However, this can sometimes lead to decisions that don’t fully account for the bigger picture, particularly when bottlenecks or constraints are not addressed directly.

Throughput Accounting’s Focus on Profitability, Not Cost

In contrast, Throughput Accounting, rooted in the Theory of Constraints (TOC), takes a fundamentally different approach. Rather than focusing on cost reduction, it emphasizes maximizing the rate at which the system generates money through sales (i.e., throughput). Key differences include:

• Throughput as a Priority: Throughput Accounting views maximizing throughput as the primary goal. It focuses on the constraint (the limiting factor in production or sales) and how to exploit it to generate more profit, even if costs remain constant.
• Operating Expenses as Fixed: Operating expenses are considered fixed in the short term, meaning they don’t fluctuate with small changes in production volumes. This shifts the focus from cutting costs to increasing throughput to cover these fixed expenses.
• Inventory as a Liability: Unlike Lean Accounting, which views reducing inventory as a cost-saving measure, Throughput Accounting sees inventory as a liability that ties up resources without contributing to throughput until it is sold. The focus is on minimizing inventory to improve cash flow, not just reducing costs.
• Long-Term Profit Focus: While Lean Accounting may focus on reducing immediate operational costs, Throughput Accounting emphasizes long-term profitability by addressing the system's constraints and improving overall throughput.

Key Difference: Cost vs. Profitability

The core difference between the two approaches is this: Lean Accounting tends to look at improving efficiency to reduce costs and optimize flow, which can sometimes overlook the system's constraints. Throughput Accounting, on the other hand, is primarily concerned with profitability and sees increasing throughput (not cost reduction) as the most effective way to achieve this goal.

By focusing on constraints rather than costs, Throughput Accounting encourages decision-makers to think strategically about how to maximize revenue generation. Lean Accounting, while aligned with operational efficiency and waste reduction, risks focusing too heavily on cost-cutting rather than understanding where the true profitability gains can be achieved by improving throughput.

Conclusion

All of the different operational decision-making methods are represented in Accounting - Cost, ABC, Lean, and throughput. But Throughput Accounting aims to increase profitability by focusing on constraints and maximizing throughput. This is better suited to the environment we live in, where a focus on Cost Reduction rarely leads to long-term profits.

Anyone who advocates Throughput Accounting faces steep challenges, however. It has to be adopted as part of a Theory of Constraints implementation and will never be universally accepted in Finance. A Throughput Accounting analysis will always have to be compared to a Cost Accounting calculation. After that, we'll have to rely on common sense.