Kaizen Budgeting

Kaizen Budgeting is a methodology used in adding quality on the final product through continuous improvement in processes used which end up reducing the average cost of production. It is different from cost cutting approach which is applied by companies or governments during times of financial crises such as cost adjustment programme adopted by the Kenyan government around 1992 when the aforesaid government stopped employing its own public workers such as teachers.

With Kaizen budgeting, the organization in question works in harmony with its employees and try to identify opportunities that can be utilized to reduce average cost of production without necessarily reducing employees’ salary or laying them off.

The main aim of Kaizen budgeting is to achieve a set target profitability level by reducing cost per unit in a smart way. Therefore, Kaizen Budgeting applies where the focus is reduction of the cost incurred on a product.

Why is Kaizen Budgeting necessary?

Kaizen Budgeting is necessary to increase competitive edge of an organization.

How does Kaizen Budgeting work?

Kaizen Budgeting works as follows, the management identifies the specific planned improvement project, then locate possible areas that require improvement leading to cost reduction. The following graphical and diagrammatic illustration will help you understand the idea in a better way

 Graphical approach of Kaizen Budgeting

At the same level of output, the management together with all other participants in product design and actual production, they identify possible cost reduction opportunities. This opportunities may be both internally or externally identified then applied.

Steps of reducing Average Cost-Cost/Unit

Step One:

At the original level of Average Cost (i.e AC1)

The management may identify that the raw materials used before were of low quality which used to result to a lot of wastage during production, such that efficiency of input-output process was low. Now, with a deeper insight, the management have identified better quality raw materials from a new supplier.

Engaging the new raw material supplier results to reduction of production cost from AC1 to AC2 whereby AC2 is less than AC1  (AC1 <AC2)

NB1: That the level of output is still the same at QConstant.

Step Two:

With the help of the employees, the management may realize that with only day shift, the employees get extremely exhausted and therefore their productivity level decreases. The management creates two shifts which are rotational in nature such that we have day and night shifts with the same number of employees.

As a result, the number of hours spend in production of a product reduces by let say 20%, as it is in the learning curve theory. This further reduces average cost from AC2 to AC3 whereby AC3 is less than AC2  (AC3 <AC2)

NB2: That the level of output is still the same at QConstant.

Step Three:

The management may realize that during lunch break, the casual workers walk far to get their lunch. With agreement with them, an outside catering service provider is engaged such that when the lunch break starts, already food is at the gate. This further reduces cases of paying for idle workers. In other words, paying for labour hours not worked for. This reduces cost of labour and by extension average cost from AC3 to AC4 whereby AC4 is less than AC3  (AC4 <AC3)

NB3: That the level of output is still the same at QConstant.

Step Four:

On identification of another cost reduction strategy such as nth strategy, this will further reduce average cost AC4 to AC5 whereby AC5 is less than AC4 (AC5 <AC4)

NB2: That the level of output is still the same at QConstant.

About the Author - Dr Geoffrey Mbuva(PhD-Finance) is a lecturer of Finance and Accountancy at Kenyatta University, Kenya. He is an enthusiast of teaching and making accounting & research tutorials for his readers.