The notion of output capacity came after Essentials, because I had not yet separated the two logically. I thought capacity was capacity. I was wrong.
When you buy input capacity, you can use it to do work. Space can accommodate offices and production lines. People can hire others, serve others, design, make, and do things. Materials can be used to perform work or be used in the conversion process of manufacturing products. When you buy input capacity, the output capacity or what you can create from the input, can be affected by many factors, such as knowledge and skill sets. Two people who work the same eight-hour shift will have different levels of output. Other factors affect output as well. Policies and procedures can limit how much output one can create. How efficient or inefficient a process is, too, can influence how much output is created.
It is by understanding output capacity that you can begin to understand why accounting fails and why you need surrogate information to get your arms around operational and financial data. There are two very important attributes of output capacity:
1. Output capacity consumes input capacity.
2. There is no cost transaction involved when output capacity consumes input capacity.
When you buy input capacity, you are buying something you expect to turn into work or to be consumed in the creation of work and work products. Creating work, therefore, consumes the input. Let’s assume you have a worker who creates reports. You buy them for eight hours. If each report takes an hour to create, one hour is consumed of the eight hours you bought with each report.
When you consume input capacity, there is no cash transaction involved. Remember, you purchased the input capacity and you have it for use. This is a costC transaction. The employee making reports doesn’t create a cash transaction with each report. The cash is tied to the fact that they’re there and available to you to do the work that you need.
This is a key reason accounting fails. The primary focus of costing is to put a dollar value on output—the consumption of input. It attempts to do this by force-fitting a relationship between input capacity and output capacity that does not exist. However, when you consider the attributes of both the input and output capacity, it becomes clear this cannot happen.
The next chapter will begin to consider the relationship between input capacity and output capacity, which becomes the basis of the information you’ll need to manage more effectively.