ABSTRACT

A ligning strategy for any company requires addressing the issue of executive incentive plans and the conflicts inherent in attempting to alignlong-term and short-term profit objectives. I had the opportunity to explore how to use the Theory of Constraints concepts and tools to integrate economic value management (EVM) principles. The work revolved around using TOC to design executive incentive systems based on return on investment (ROI) both long and short term. Consistently, Goldratt’s simplistic approach of tying compensation to cash flow — advocated by the throughput, inventory, and operating expense measures — has been correctly criticized for not recognizing the need for long-term vision in executive decision-making. Using direct costing for inventory valuation corrects the distortions of standard cost accounting and negates the opportunity for creating false profit through inventory manipulation but does not address the long-term vision. As companies move further into a low work-in-process and finished goods inventory environment, the distortion of traditional standard cost accounting becomes less and less an issue. The remaining hurdle is to restate financial statement profit to best align executive strategy and decision-making with both short-and long-term results. How do you allocate resources? How do you measure performance by top management on the use of these resources? How do you pay or reward the management group for performance? Consulting firms are attempting to answer these questions using EVM to adjust standard financial accounting statements. The EVM adjustments have four major objectives and are compatible with TOC:

1. Move from an accrual basis to a cash basis to arrive at the correct timing of an expenditure — accrual of bad debt reserve vs. write-off of bad debts.