In capital budgeting you can ignore most of the details. The ones that are the same under any alternative. That makes sense for two reasons:
- Identical expenses or revenues cannot influence my decision because there is no deciding information contributed. If municipal taxes are the same whether I buy or lease a building, then their presence or absence will not affect my decision.
- Extra detail distracts. It diffuses attention and forms the debatable material for people who do not want to make or cannot make a decision.
The skill of ignoring things that are the same under all conditions or are not relevant to the decision at hand is a good one to acquire. The essence is to think “on the margin.”
There are three decision spaces:
- The space of all the things I do and will continue to do
- The space of all things I do not do and will continue to not do
- The space of things where I may or may not cross over the border between do or not do.
Decisions in space 1 are primarily about details. How I do it? How much should I pay? Who does it? Things like that. They are maintenance.
Decisions in space 2 are limits of one kind or another. I have too few resources. I have physical or skill limits. My principles do not not permit it.
These are mostly strategic.
Decisions in space 3 are ordinary and require some thought.
You cannot cross from not doing to doing without money resources, time, skill and effort. There is risk. There may be several ways to do the same thing. Maybe some are better. There may be social consequences. In any case, having extraneous variables or people involved will not improve the decision.
On risk, notice an important concept. Anything you can reverse for little or no cost has no risk. For example, buying a particular house has little risk. If yo don’t like it, you can resell it and be out some money at worst. On the other hand selling a family home is much more risky. If you want it back you may be stymied.
How to do it is straightforward. Plan A versus Plan B in columnar form. List the specific factors of each with the costs or values in each column. Stroke off the ones that are essentially the same.
Examine ways to modify and understand differences if possible to do so. Would a longer lease and a lower monthly payment makes sense on an airplane? Maybe, but maintenance costs would go up. Maybe I already have an underutilized maintenance facility so the added cost would be small. Possibly just parts.
Decisions restricted to marginal differences are usually easier. The best part of it is that people know why they made the particular decision and they know what could change in the future and maybe even know how they could deal with that.
Knowing why motivates. It gives you purpose and an element of control. Try to make decisions that have a clear why.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.