Budget Evolution

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Budget Evolution

Without specifically calling it a budget or a plan, it has always been part of our lives, either for business or personal projects. People need to know where they are heading. It is part of a sound process.

Take for instance a newlywed couple. Usually, the major component of their plan is to start a family and find a house where they can raise their children. To achieve that goal, they will normally identify all the related expenses. The couple’s next step is to find the revenue to match these expenses. Some more fortunate might have the help of family members, some will not. If the couple cannot find the equivalent revenue they will have to revise their plan or sacrifice on the quality of their household. In this small model, the biggest cost driver is the number of children. Yes! And it is a big one... At the beginning, children do not need much, but when they start to get older their needs are considerably growing (in quantities and in varieties). If this is not planned correctly, the couple will be faced with some serious decision-making.

Calling children the biggest cost drivers may sound cold and harsh. The point is that budgeting and planning is a very old process, and we do not need to look far away to see how it touches us and how complex it can be.

One cannot talk about budgeting without including cost accounting. Both of them are closely related. In the first half of the 20th century, industries were producing few different products with high quantities for few different customers. Back then the financial statement could be considered as their product costing sheet. Nowadays, the complexity and variety of their products as well as their customer demands have all increased considerably. Therefore the old product costing sheet (financial statement) is not sufficient anymore to get the real picture of their products/customers profitability. This challenge gave birth to a much-needed discipline: Cost Management. From there numerous different types of costing have emerged such as ABC costing, target costing, constraint costing…

Now going back to the planning and budgeting. If it is so closely related to product costing how can we ignore its complexity when making a budget? In our newlywed couple example, if they do not consider how many children they will have, and ignore how complex it is to raise children, we can be sure that they will end up with a big hole in their budget. The same applies to any company. If we do not integrate the product costing behavior in our budget we will be faced with big surprises.

The biggest challenge that we all face is that reality is never as we planned it. We often hear, ‘If only I had a crystal ball!’ . Well we better get used to it, none of us has one and none of us will ever have one. Therefore, how can we cope without this precious gadget? By integrating the product cost behavior in our planning and budgeting, we can at least do two things:

1. Reset the budget costs using the actual cost drivers for proper cost comparison and variance analysis. For example, if the couple planned to have two children and they ended up with three, therefore all the direct costs related to the children will go up by more or less 50%. This is only one of many variations that can happen during a lifetime. Surely you can think of a lot more.

2. Make scenarios that will partially replace the crystal ball. In conclusion, years ago companies did not need to have complex budgeting tools since the production, the market and the customers were not as complex as they are now. Nowadays, the global economy and the resources limitations are making it even more difficult to establish a sound budget. Our biggest challenge is to integrate the complex reality into a planning and budgeting environment without ending up with a budget that is unmanageable due to its size and complexity. (cb)

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