Traditional approach is whereby plans and assumptions are made for the factors that will influence the following years budget and approval of the budget is made before the budget year begins. Monthly reports are made once the budget year has started to compare the budget and the actual performance on a monthly basis and thereafter action taken where necessary to correct the differences. Normally in traditional approach, budgets of every department are approved before the year begins. Traditional approach is adopted by many organizations today whereby forecasting is done early in advance and minimal changes occur in the actual budget cycle. The traditional approach however is appropriate for some organizations and not others since it has its advantages and disadvantages. This is due to the fact that the traditional approach is not appropriate for a dynamic changing business environment since it is not flexible with the everyday changing business situations. (Gennard, 2005)
Advantages of the traditional approach
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Some of the advantages of traditional approach are:
Income and expenses of a budget period can be compared in order to approximate the amount of returns to expect
In the traditional approach, the budget can be compared with the performance to know the variances that have occurred and correct them.
Reports that are formulated from the budget can help to access the costs and achievements of the business entity.
It is a good method to use for a stable business in a stable environment. (Rose, 2008)
Disadvantages of the traditional approach
Some of the disadvantages of the traditional approach are:
It relies on prediction of what will happen in the next year which is not reliable since the business environment is changing thus may not be appropriate for a rapidly changing business environment. (Lewis, 2003)
The traditional approach is not flexible thus inappropriate for a changing business environment.
In the traditional approach the budget is incorrectly timed which in most cases it takes a very long time which may make it inapplicable by the time of completion since in most of the cases the business environment would have changed. (Hollinshead, 2003)
The traditional approach is expensive and not very efficient. It is inefficient since it cannot apply in a rapidly changing business environment.
For the businesses that operates in a very stable and static market place, where there is little change in either products or demand year on year
In this case, traditional budgeting method would be the best. This is due to the fact that there are minimal changes in the market place and there is stability. So if a prediction is made on the following year most of the case it will be true since even if there would be changes the changes would be minimal and thus wonâ€™t make a big difference to the decision made. Traditional budgeting in this case would be easy since there will be simple coordinationâ€™s of assumptions of budget for different departments. With the traditional approach therefore, one will be able to enjoy the benefits of using it such as: One can know the benefits to expect by comparing the income and expenses of the budget period, One can know the variances in the business by comparing the budget and the performance, and one can know the performance and the costs from the reports that one gets among many others. Variance analysis is what is commonly used for the calculation of the rate of the variance between the actual performance and the planned budget which is known to be a traditional method thus not appropriate for a modern business as much as it is commonly used in the traditional approach. (Gennard, 2005)
As much as the traditional approach is good for this kind of business, it is important that a change is made with time since a long usage of one style may lead to boredom of the employees which may affect the performance of the company. Even though changing the budgetary control method may be expensive, it is important that it is changed for the good of the organization. An alternative that can be used for the traditional approach is Zero-Based budgeting. (Rose, 2008)
Zero based budgeting
Always on Time
Marked to Standard
This is whereby the managers get back to basics by identifying the goals they have in relation to the organization and the activities and projects they plan to undertake for the achievement of those goals. In this the activities and projects are normally ranked according to the level of priority whereby those with high priority are ranked first then the rest. The resources will then be allocates according to the level of priority of the activities and projects. (Leat, 2001)
Some of the advantages of the approach are that: It helps to reduce the costs that may be suffered, help s to foster discipline among employees and managers as far as budgeting is concerned, and it makes budgeting to be more efficient.
Some of the disadvantages of the zero based budgeting is that: It might be timely and more costly; it may not serve its purpose well if not conducted well.
Despite the fact that zero based budgeting has disadvantages, it is highly recommended for businesses in a static environment for them to improve on their performance since it is much better and an improvement of the traditional approach. (Dicker, 2003)
For the business operates in a very dynamic, rapidly changing, innovative environment
In this case, the traditional approach would not be the best method to use. This is due to the fact that the business is operating in a dynamic rapidly changing innovative environment and the traditional approach is not flexible for this kind of environment. The fact that the traditional environment relies on predictions for the coming year, it cannot make the correct predictions since the environment is rapidly changing and in most of the cases the predictions that it will make will not be applicable in this case. The traditional approach uses the wrong timing fir the budget which in most of the cases is a very long time and by that time the business environment would have changed making it inapplicable for that. The dynamic, rapidly changing innovative environment is exposed to so many risks thus its needs a more flexible budgetary approach and thus there are many alternative approaches that can be used for the budget. Some of the alternative methods that can be used include:
Beyond budgeting approach
This is an approach that was created to give an alternative to the traditional approach and thus is more flexible giving the managers the chance to change the decisions they make according the state of the environment and thus they can exercise beyond budgeting. Beyond budgeting mainly focuses on performance which is reliant on the environment and thus gives the chance a business to change according to the current environment. It is governed along 12 principles that allow the employees to respond well to competition and demand as well as performance. Beyond budgeting is said to help an organization to grow since it aims on improving the performance of the employees as well. It is a good measure since: it ensures comparisons are made against competitors and past performance; it deals with the key factors that affect the performance of the business, ensures the business takes advantage of the changing business environment, and ensures the business responds well to potential threats on time. The main problem of adopting this budgeting system is however that in most organizations there will be resistance to change although this is dependent on the culture and the kind of employees of an organization. (Gennard, 2005)
Activity based budgeting
This is a kind of budgeting system that is an alternative to the traditional and the beyond budgeting approach. In this kind of approach, budgeting is made based on the activities of an organization. The activities and resources of a company are the determinants of the budget that will make and from their assessment is when a financial budget will be made. (Hollinshead, 2003)
Some of the advantages of the activity based approach are:
It enables managers to do better decision making since the decisions made are based on the activities and this will help in the attainment of organizational goals. (Lewis, 2003)
It is more flexible and adjusts according to the changing business environment and changing activities of an organization.
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It helps to improve the performance of managers and employees in general in an organization since it makes it easy to do performance measurement and evaluation
Activity based budgeting is more accurate since it will make managers to make more accurate decisions regarding forecasting of the future budget of an organization. (Hollinshead, 2003)
Some of the disadvantages of the activity based approach are:
It does not give a connection between activities and resources
It is difficult to understand the rules linking outputs to resources and costs. (Leat, 2001)
A report on how each part of the working capital cycle could be improved and the implications of the improvements on XYZ and other connected parties
It is important that each part of the working capital cycle is improved for the good of the company. If every part of the working capital is improved it will translate to higher returns by the business. (Gennard, 2005)
Cash is the main thing that is involved in the working capital. In this case a company should focus on things that absorb the cash in the organization and reduce their rate of absorbing the cash. This means that the company should focus on inventory and receivables. Inventory includes stocks and work in progress while receivables are debtors who might owe the company some money. The main sources of cash for the company are payables and loans and equity as well as grants. This means that XYZ limited company needs to manage well the cash inflow and outflow for the benefit of the business. It should therefore strategise on how to get more inflow than outflow since that is what will determine the profit margin of the company. This basically means it should minimize the flow of inventory since it will lead to the consumption of more cash in the long run, though the flow of inventory is minimized, its shift should be made fast in order to free more cash. The debtors should be left to stay with the debt for longer as this will mean that they will be able to pay more profit which will make the company to get more profits. Credit should also be gotten from good sources with good deals to ensure that the company does not have to pay a high interest which may affect the cycle. Working capital can also be improved by selling long-term assets for cash and this will help the cycle to have cash which can be used as working capital. The account receivables should also be collected sooner that it was supposed to be to make the company to get cash. The cash from accounts that are doubted should be reduced so that the cash is safe and available as working capital. The company should also opt for long-term debts rather than short term debts since it will help the company to have more cash. (Rose, 2008)
By there being more cash will mean that the company will have more working capital which will mean that the company will have normal operations which means that it will have more profits and better performance. (Jennings, 1990)
This is the amount of money that is gotten by a business from the sale of its goods. One should manage the trade receivables well for the company to have working capital. This is due to the fact that managing trade receivables is tricky and determines if the money will be available for working capital or not. The time the receivables are received has a big impact on the business. In this case if they are collected faster cash will be released from the cycle and if they are collected slower it means that they will make the cycle get more money which will be for the good of the business. (Hollinshead, 2003)
Inventory of raw materials
The inventory of raw materials is a great determinant for the availability of working capital in the cycle. This should be determined by the amount of sales that has been made. This is due to the fact that if more inventory of raw materials is purchased and fewer sales made it means that itâ€™s going to tie cash which will affect the availability of cash for working capital which will hence affect the cycle in general. (Dicker, 2003)
Work in progress
Work in progress is also a type of inventory that uses up the cash of the business. The way it is managed therefore is very important as it is what will determine the availability of cash for the working capital cycle. The work in progress should be managed according to the amount of sales that is made such that it is not more than the sales that is made since it will constrain the amount of cash that will be available in the working capital cycle. (Lewis, 2003)
Finished goods are the ones that will be available for sales and make the company to have more cash which will be available as working capital. The more the sales made the more the working capital hence finished goods is the main determinant of the working capital that will be available for the business. The finished goods therefore should be strategized on how they should be produced and sold since this will determine the working capital that will be available. They should be produced according to the amount of sales that will be made such that there is no overweigh on the amount of finished goods. If the finished goods are not proportional to the amount of sales that can be made it will mean that it will hold more cash and thus less cash will be availed for working capital. The way the finished goods move will also affect the availability of the working capital such that if they move faster more money is made than the money consumed. There should therefore strategies put in place on the way the finished goods should move and how to make them move faster for the company to get more money which will be available as working capital and thus make the cycle complete. (Gennard, 2005)
The right customers should be chosen for the finished goods for the company to get more money for the cycle. This is due to the fact there are those customer that are willing to pay more than others and this will mean more profits earned and thus more money available for the cycle. This can be achieved by doing more advertising to make the brand stronger and also get more customers which will lead to increased in sales which means faster flow of the finished thus more profits and more cash available for the working capital. (Hollinshead, 2003)
These are a source of cash for the business. They include creditors and other source of funds which may be loans, equity among others. Time factor is very important when it comes to trade payable since it is what will determine if the company will have cash for the working capital or not. For example a longer credit limit will mean more cash being available for the business since there will be more free finances that would have been used in paying the debt. Better loan conditions should be sought for to make sure that the cycle can have more money when there is need. The right strategies should also be employed such that when there is need for money the right source of cash is sorted for the business to have money for the working capital. This is due t to the fact that there might be challenges that may make the business to run out of funds and this may paralyse the system and therefore having the right source of funds will make sure that the company has constant supply of cash for the working capital cycle for the cycle to be complete. There are many sources of finance in the market so they should be carefully selected and analysed for a good deal to be sought that will not burden the business. (Rose, 2008)
Despite the many options that could be sought to ensure liquidity in the working capital, precautions should be taken since there are effects that have to be faced which will be affected on the business. The manager should always make sure that the cash outflow is not more than the cash inflow since if it is more it will mean that the company will experience losses which will lead to the downfall of a company. If there is need for the trade payable, one should first consider the trade receivables and make the debtors to pay the debts. If the debtor can pay the debts it will be better for them to pay the debts than taking another loan. Instead of taking a loan, the company can also see if there is a long term asset that it does not really need that it can sell to get money. The company can even look for a good deal to make sure that the asset earns them good money and the timing for the sale of the asset is also important as it should be sold at the right time for it to get more money. (Lewis, 2003)
In all this to maintain a good working capital, one needs to have a good plan as planning is what will determine the success of liquidity in terms of working capital. A plan will ensure that good timings are made which will intern ensure that the company gets more money hence it is successful. A good working capital being maintained is very important as it has ma y advantages attached to it. It is what will ensure that there are more returns and the business is able to grow and beat the competitive edge and that what defines success. (Hollinshead, 2003)