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Tanaka, T. 1994. Kaizen budgeting: Toyota's cost-control system under TQC. Journal of Cost Management (Fall): 56-62.

Summary by Rosalyn Mansour
Master of Accountancy Program
University of South Florida, Summer 2002

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This purpose of Tanaka’s article is to explain Toyota’s budgeting and manufacturing control systems, both of which are integral to the achievement of Total Quality Control (TQC). Tanaka begins by explaining some oft used Japanese terminology such as "kaizen" (continuous improvement) and "kanban" (Just-In-Time Manufacturing) and how the budgeting system relates to the just-in-time system (indirectly - these systems can share data for analysis purposes and are all related to TQC).

Next, he explains that Toyota’s budgeting system is not purely based on target costing, but instead on cost control, target costing, and kaizen. This methodology is unique in that: (1) senior management has ultimate responsibility for making a profit and for administering the budget because there are no profit centers; (2) having no profit centers, there is no need for transfer pricing, which eliminates biased performance evaluations; (3) the goals set for employees are in terms of kaizen and tend to motivate employees because kaizen is simple and understandable by all; and (4) the same high standards are required of like processes, regardless of what individual plant the process in performed. These unique characteristics of the budgeting system support Toyota’s management clarity of vision needed to plan for the future and it provides the tools in which to motivate employees and attain high uniform quality throughout the organization.

Tanaka goes on to explain that Toyota’s budgeting system is totally separate from its financial accounting system and is very different from most budgeting systems. Some of these differences include: (1) Emphasis is on variable costs. (2) Budget goals are in terms of variable costs to be reduced via continuous improvement. (3) There are many cost centers (4) Indirect costs are not allocated to products (4) The budgeting system supports a matrix organization.

Next, Tanaka describes Toyota’s control structure, which is a matrix of vertical job-specific units and horizontal function–specific controls. One of the main function-specific controls is cost control and is comprised of target costing and kaizen budgeting functions. Additional functions that support cost control are: "planning, technology, production, sales, and personnel & general affairs (58)." Councils, comprised of 10 board members, closely monitor the aforementioned functions and are responsible for strategic decision making. As such, each council makes up a functional budgeting component.

Finally, Tanaka gives a detailed description of Toyota’s budgeting system. He notes that upper management determines both the short-term target profit and the long-term sales-to-profit ratio, one year in advance. A sales council determines sales targets using a formula. Estimated Sales is then used, in combination with a sales-to-profit ratio (projected 3-5 years into the future) to determine a target profit (See Exhibit 1 and formulas below the exhibit). The budget is based on a profit target and volume of production and is segregated into variable and fixed costs budgets.

The fixed costs budget is further segregated by function (For example, the sales costs budget is prepared by the sales council) and usually contains what is termed as "uncontrollable" and "controllable" costs. Uncontrollable costs are those that have no room for cutback, but they can also be those types of costs for which reduction would impair growth (such as dealers’ sales margins).

The variable costs budget is mostly concerned with those production costs not related to parts acquisition, as the cost of these raw materials cannot be simply reduced because they involve negotiation and there are complex considerations that go into these purchase transactions. These remaining variable production costs (variable production costs - parts costs) are controlled by the kaizen budget, which shows only the kaizen value in the variable cost section. Tanaka defines "kaizen value" as the reduction in cost that can occur by altering the cost standard (60)." First, the variable cost of something is determined, then possible reductions in cost can be estimated. Once both fixed costs and variable costs have been estimated, profit is then determined. See Exhibit 2 for formulas to determine materials costs, product costs, and estimated profit as provided by Tanaka on page 60.

By this point in the process, both target profit and estimated profit have been calculated. Target profit is desired. The difference between the two is kaizen value. To get congruence between target profit and estimated profit, Toyota must both increase sales revenue (units sold or price per unit) and cut costs. Both methods are each half of the equation for eliminating the spread between target and estimated profit and of achieving kaizen. In other words, half of the spread must be eliminated by increasing sales revenue and half by cutting costs. It is preferable to increase Sales by increasing the price per units sold than it is to increase the volume of sales (variable costs increase as production increases thereby making it more difficult to cut costs). To cut costs, Toyota focuses on controllable variable production costs and requires across the board cuts to improve the cost standard for each major production process (also known as kaizen units).

Kaizen units are segments of the production process that exist only for the kaizen value distribution purposes and for the accumulation of variable costs. Kaizen values are distributed by the production function council and then further distributed to the individual plants based on established rates. For example, one plant may have kaizen value distributed to it for casting and another kaizen value assigned to it for set-ups. The managers in charge of these areas of the plant are responsible for attaining the kaizen value assigned. The sum of these two kaizen values equals the plant’s total kaizen goal. The plant manager is responsible for attaining the total kaizen goal.

Tanaka ends by explaining that, once the kaizen goals have been established, plant managers submit plans for achieving these goals twice a year (July & January). Such plans include improvements in every day operating procedures as well as more technical analysis and engineering changes. According to Tanaka, in 1991 alone, there were about 2 million TQC-related suggestions from employees. This worked out to about 35 per employee. Of the 2 million suggestions, 97% were adopted (62).

Toyota's Budget System

Calculations of Target Profit(From page 59)

Target profit P can be shown as follows:

P = S x p'
Where S = Target Sales
P' = Sales to profit ratio

Target Sales (S) = Ui x Qi
Where i=1
Qi = estimated sales volume.
Ui – unit price for the model.

Exhibit 2 – Materials costs, Part Costs & Estimated Profit (From page 60)

Materials cost (ye) = (ei)(ri)(qi)
Where ei = Units of consumption.
ri = Unit price.
qi = Production volume.

Part Costs (W) = Sum of Ak
k = 1 where Ak is the number of different materials used for part k.

Estimated Profit (P) = S – (F + B + V)
Where S = Sales target
F = Fixed Costs
B = Parts Costs
V = Variable Costs


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