Page 459 - Design for Six Sigma for Service (Six SIGMA Operational Methods)

Theory of Constraints 417

12.2.1 Throughput, Inventory, and Operating Expense

In the theory of constraints, there are three key measures for the mon-
eymaking process: throughput, inventory, and operating expense. The
definitions of these concepts are slightly different than those people
usually refer to.
Throughput The money produced by the system is called throughput.
By adding the time factor, throughput is also defined as the rate at which
money is generated by sales. The regular definition of throughput often
refers to the production output per unit time. In the theory of constraints,
the production output is not a throughput unless a consumer purchases
it. Throughput is also not gross revenue, because some of the revenue
might be simply components purchased from suppliers and their sales
simply pass through our process and do not add any value to us. In the
theory of constraints, the throughput is calculated by taking gross
revenue minus all totally variable expenses, such as purchased material
cost, sales commissions, and any subcontract expenses.

Inventory Inventory is the money captured (locked) within the
process. From the viewpoint of the theory of constraints, not only the
parts, unused raw material, unsold goods, but also all of the assets
(buildings, equipment, and so on) are considered as inventory.
Operating Expense Operating expense is all the money spent to turn
inventory into throughput. It includes all direct or indirect payroll
expenses, all supplies, and all overheads. In other words, all expenses
related to time are operating expenses. In general, the operating
expense is the real money you take from your pockets to produce
products or services to satisfy customers.

These three measures are related to the regular financial performance
measures, such as net profit, rate of return, and productivity. The detailed
relationships are given as follows:
Net profit = throughput − operating expense (12.1)
−
Rate of return (ROI) = throughput operating expense (12.2)
inventory
Productivity = throughput (12.3)
inventory

Based on these relationships, Fig. 12.3 shows the relationships between
throughput, inventory, operating expense, and profit.