correct relationship but this same type of confusion has been demonstrated by thousands of participants tested on fundamental operations science relationships during Factory Physics workshops and training sessions. This would be like a physicist not knowing the implications of E = mc2 or a home owner not understanding the relationship between the mortgage interest rate and their mortgage payment.
The following graph provides both the VUT equation and a graphical interpretation of the interaction of variability, capacity utilization and cycle time in the real world.
Note that cycle time blows up sooner with more variability. The gold star represents perfect performance: 100% utilization at nominal process time (t0). One of the laws of operations science is that work will not be released to a production or service process at 100% utilization over the long term. Because of variability, releasing work at 100% utilization eventually results in such poor performance, increased cycle times and inventory, that something will be done to work at less than 100% utilization to get performance back to acceptable levels. So the appropriate level of utilization depends on the amount of variability in a process and the desired response time. A job shop typically has a tremendous amount of variability and a planned utilization of 70% would make sense to provide acceptable response times. For a commodity operation, a higher level of utilization would be targeted—maybe 85%. This is where the opportunity for a truce occurs.
It is Operations’ responsibility to demonstrate this relationship to Accounting and help determine the most profitable level of resource utilization for a company. If this relationship is not understood, what typically happens is that those controlling the purse strings (Accounting) determine the performance expectations and targets. Since Accounting’s model of performance is the standard cost model, this often leads to 100% utilization targets, chaotic and less profitable performance.
In summary, the standard costing model is a good, though not perfect, model for allocating revenues to expenses—ABC accounting is just a more detailed approach to standard costing. Throughput and lean accounting show some promise but waiting till GAAP are amended could be a long wait. The point is to stop fighting over the standard costing model. Companies should use accurate operations science models to get best possible throughput and response time with minimal investment in capital (machines, people and inventory). Once that is accomplished, Accounting can happily allocate revenues to expenses however best suits financial reporting requirements. In the end, Accounting and Operations should pull together for best possible performance. – ESP
1The Papers of Alexander Hamilton, vol. 14, p. 314, “Report on the State of the Treasury at the Commencement of Each Quarter During the Years 1791 and 1792,” February 19, 1793.