Modern day business enterprises operate in extremely challenging circumstances.Whilst management and control of business organisations have never been easy, and the number of business failures significantly outweighs that of successful business organisations, contemporary business organisations need to overcome particularly challenging environments in order to achieve and maintain growth and profitability.
Business organisations have traditionally used a range of management tools to plan their operations, in accordance with their strategic objectives, for achievement of profitability and growth in diverse business conditions.  Management accounting, a management discipline that originated in the early years of the 20 century through the combined application of production, cost accounting and financial accounting techniques for achievement of business performance, provides a range of tools and techniques for planning of operations and achievement of performance. [th]
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Budgeting and budgetary control, the subject of this short study, is an important management accounting and performance management tool. In routine use in business firms, budgeting is considered to be integral to the success of business organisations. Budgeting is a detailed process that consists of various phases, involves different organisational levels and departments and is essentially multi-disciplinary in nature.
This short study attempts to analyse the use of budgets in two different circumstances, with a business engaged in a stable market with practically unchanging demand, and with another operating in dynamic and fluid environmental circumstances.
Budgets represent blue prints for organisational working for specific future periods. Prepared under the overall supervision of senior managers, budgets detail various activities that are required to be done and targets that are required to be met for satisfaction of strategic objectives.  The process starts with the definition of key organisational objectives, both short and long term, and thereafter focuses on issues like revenues, growth and operational efficiencies.  The exercise is essentially multi-departmental and multi-disciplinary in nature, even though the final figures are created by finance or management accounting departments.  Values are computed for different objectives and targets set in areas like sales, production, efficiencies and costs.  Numerous departmental budgets are meshed into one large organisational budget, which ultimately lays down quantitatively defined, phased targets for the financial and operational performance of a firm for a specific forthcoming period. 
Budgetary control is traditionally based upon allocation of responsibilities to chosen managers for achievement of specific targets.  Periodic monitoring of actual performance against budgeted targets enables managers to assess the level of actual organisational performance, analyse reasons for variances between actual performance and budgeted targets and take corrective action where such action appears necessary. 
Budgets vary in size and complexity and can range from a four page document for a small business firm to a huge ERP system produced volume, covering hundreds of products, various departments and various locations across the globe, for a large transnational corporation.  Budgeting, it has traditionally been felt, has numerous advantages.  The commencement of a budgeting exercise involves analysis of business performance, study of existing and projected environmental issues, and ascertainment of existing strengths, weaknesses, opportunities and threats of individual organisations.  Such an exercise, which is essentially multi-departmental, multi-disciplinary and involves the participation of internal managers and external experts, is useful for establishment of organisational objectives, determination of available business opportunities and construction of appropriate business objectives and plans for the coming year.  The preparation of a budget unifies an organisation through a jointly created multi-dimensional plan of action in which all organisational members have ownership and to which they are jointly committed. 
Always on Time
Marked to Standard
The monitoring of budgets with actual performances during the period of their currency helps organisational members to understand and appreciate the results of their combined efforts and the areas in which corrective work needs to be done, both in the immediate and long term.  The use of such budgets should thus prima facie be useful to all commercial organisations, albeit in different degrees, irrespective of their engagement in static unchanging activities or in rapidly altering business environments. 
Organisations operating in environments that are expected to show little change should moreover be expected to benefit more from traditional budgeting exercises, because the setting of budgets for such organisations can be expected to be simple, their reliability can be expected to be strong, and their assessment and monitoring easy and accurate. Budgeting in such organisations can be expected to provide managements with sufficient wherewithal for adequate performance monitoring and management. The use of budgets and budgetary controls in such situations may well be adequate for achievement of organisational objectives and for carrying out route corrections, as and when required.
In actuality, the usefulness of budgeting, as a tool for setting and achievement of operational targets, is subject to a number of factors for all types of firms.
Such tools can prove to be inadequate in the modern day business environment, which is essentially dynamic in nature, where business conditions change swiftly and dramatically, and where forecasts for future periods may well be misplaced. Recent years have witnessed the occurrence of enormous change in business environments.
Competition between businesses, local and foreign, has increased manifold. Advances in technology are leading to short product life cycles and rapid product obsolescence. Huge global corporations are losing their dominant positions in the international economy, even as small garage start ups are growing to become huge global businesses in astonishingly short time frames. There is little stability in business and even long established business areas are being buffeted by the impact of fast and unpredictable change. Such factors can sharply impact the effectiveness of budgeting in both stable and dynamic environments.
The setting of budgets is dependent upon the analysis of existing and projected business conditions and perceptions of individual organisational managers about what can be achieved in coming periods. Both these issues are complex and have numerous implications. In the first place businesses cannot be thought to be static. Managers who perceive their businesses to be static pay heavily for such short sightedness, as history has proved time and again. Threats can occur from the most unexpected quarters and demolish conservative and traditional businesses in extremely short periods. Typewriter manufacture was considered the most stable of businesses until the personal computer came along and sent typewriter producers into oblivion in a matter of years.
There are numerous such examples that highlight the errors involved in thinking of any business to be stable or static in nature.  Budget making in such "static" circumstances can even otherwise be adversely affected because of (a) intentional actions by managers with regard to modifying budget figures because of their personal agendas, (b) lack of co-operation by any of the numerous people involved in the making of budgets and (c) inadequacies in understanding the realities facing particular organisations.  Careless budgeting, even in conventional businesses, can lead to the setting of unrealistic targets, place undue pressure on responsible officials, and lead to reduced employee motivation and intra-organisational friction.  Budgeting in large organisations is also an extremely complex and often cumbersome process that is difficult to manage and is often used more because it is felt to be a sacred cow rather than an effective management tool. 
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Whilst businesses operating in "stable" environments can expect to face such challenges in their use of budgeting tools, such problems can become intensely accentuated where business environments change swiftly, needing firms to respond appropriately.  Fixed budgets, spanning specific periods, say quarters or half years, are likely to become irrelevant in such environments.  The imposition of orthodox budgetary control practices in such situations can bind organisational managers to set ways and actions, reduce organisational initiative, and route organisations into inappropriate and ultimately detrimental directions. 
The Way Forward
Kaplan famously asserted in the late 1980s that existing management accounting techniques had become inappropriate for contemporary businesses because they had not responded for decades to changes in the business environment.  Whilst managers in the past were hampered by the lack of management tools, other than traditional budgeting, for achievement of their business objectives, the situation is better today. 
Many organisations, especially those operating in dynamic and fluid situations make use of rolling budgets and dynamic budgetary control techniques.  Rolling budgets leverage new developments in the budgeting process and self correct every month.  Dynamic budgeting adapts to volatility and is substantially flexible. It flows from business strategy, does not constrain operations through predetermined yardsticks, and helps organisations to respond swiftly to environmental changes.  Apart from the use of dynamic budgeting techniques, the use of sophisticated ERP systems can help modern day organisations to factor numerous business variables into the budgeting process, and ensure that budgets take cognizance of different environmental factors and variables. 
The use of the balanced scorecard helps organisations to convert strategic objectives into performance metrics from four different perspectives, (a) short and long term objectives, (b) financial and non financial measures, lagging and leading indicators, and (d) internal and external performance, and enables performances to factor in the effect of changes. 
The use of such techniques is increasing in business firms that operate both in stable and in dynamic environments. Whilst more complex than traditional budgeting tools, they are more holistic and multidimensional in nature than traditional budgeting and more suited for the unstable modern day environment.
Part A Word Count 1523
XYZ Company manufactures and sells industrial products to a range of industrial buyers, who use the company's products in the manufacture and assembly of their own products.
The working capital cycle of the company starts, appropriately enough, with cash, which is first converted into inventory, thereafter into finished products and debtors, and finally back into cash.
The Managing Director of XYZ very rightly feels that the operations of the company can be significantly improved through the improvement of its working capital management practices.
This report attempts to analyse the reasons for inefficiencies in working capital management and recommend ways and means for its optimisation.
2. Working Capital Management and Areas of Concern
The working capital of a business firm in the manufacturing sector represents the capital required to finance its regular working by way of providing for (a) its various inventory needs, (b) its requirement of cash for regular operations and (c) its debtors. 
Whilst some amount of such working capital is made available by vendors who supply goods to the company, the balance is contributed in most cases through a combination of short term bank borrowings and owner funded equity. 
With working capital funding being expensive, (because of the application of cost of capital and cost of bank interest), reduction of working capital automatically leads to improvement in profitability and return on investment (ROI). 
The components of working capital are associated with vital business areas, making efficient working capital management a complex and challenging task. 
Business organisations need to necessarily carry stocks of raw materials, work in progress and finished goods in order to meet the needs of their production lines and their buyers.  Reduction of inventory of raw material can lead to stock outs and consequent stoppages of production.  Absence of finished goods can lead to failure in business commitments for supply of equipment to buyers with consequent buyer dissatisfaction and the possibility of penalties and loss of business. 
Debtor balances on the other hand represent monies that are owed to organisations by their buyers and arise from the terms of trade that are agreed upon between two organisations or which exist within specific industries.  Most companies have to accommodate their buyers by providing them with credit, which can differ in duration from a few days to many months.  With organisations having to incur costs on their finished products, because of expenses incurred on material purchase and various operational and administrative expenses, monies blocked in unpaid debtors can often become substantial. 
Cash is required to be kept in the business for meeting regular operational needs, as well as for unexpected contingencies.  Absence of adequate cash can lead to commitment failures, both inside and outside organisations.  Such failures can often have very grave business consequences.  Failure to meet organisational salaries can lead to organisational unrest, employee de-motivation and lowered productivity.  Failure to pay taxes or bank dues can cause detrimental legal action, whereas the inability to honour commitments to suppliers of material can result in stoppage of material supply and reduction of production. 
Most operational business managers tend to err on the side of caution and prefer to keep substantial stock of raw materials, work in progress and finished goods, lest they suffer from the consequences of material unavailability.  Sales departments often agree to unfair buyer demands regarding provisioning of credit and do not push collections that are due because of fears of upsetting buyers.  Accounting departments tend to keep additional cash in bank accounts out of apprehensions of underachievement of future cash inflows, forcing them to run from pillar to post to meet unavoidable organisational cash commitments. 
With part of working capital being financed by creditors, purchasing departments try to get the maximum amount of credit from suppliers, often by playing different suppliers against each other, rather than by asking for discounts on early payments. 
Such predilections on the part of both operational and financial managers lead to the entrenchment of inefficient and expensive working capital management practices.  The desire to keep adequate inventory across all categories, namely raw materials, work in progress and finished goods, leads to the setting of high reordering levels, excess purchases, build-up of stocks of underutilised material, obsolescence, and pileups of stocks of finished goods.  Obsolete or unusable material often has to be disposed at scrap value at considerably low prices.  On the other hand over-stocking of material, which can deteriorate in quality over long periods, (like rubber products), can also cause financial losses consequent to their being determined as unsuitable for consumption.  Debtors, if left uncontrolled, can bloat to abnormally high levels and become difficult to recover.  Delays in payments to creditors can discourage good suppliers from doing business with the company and lead to higher purchase costs.  Inefficient working management practices, as is evident, can lead to substantial operational losses in addition to the incurrence of unnecessary finance charges, blocking of capital, and opportunity costs on such blocked capital. 
With working capital management essentially being based on the determination of optimal working capital levels that enable organisations to work smoothly and yet avoid unnecessary costs, management and financial academics have for been wrestling with the determination of optimum levels of inventory, debtors, cash and creditors.  Much of the recommendations in this area have come from the banking sector, through the formulation of working capital ratios like Current Ratios and Quick Ratios.  These ratios, which deal with the adequacy of current assets to current liabilities, look at working capital from perspectives of financial stability and have little to do with optimal management of working capital.  Such ratios are moreover recommended uniformly for different industries and are essentially arbitrary in nature. 
3. Discussion and Recommendations
Working capital management practices, from operational perspectives, have to thus be formulated and implemented by organisational managements after taking account of various operational needs and environmental realities. 
Japanese managers have been instrumental in the formulation and implementation of thoughtful and innovative inventory control systems that have changed the concept of inventory management and practically revolutionised purchasing and inventory management processes.  Japanese Just in Time (JIT) management systems aim to reduce levels of raw materials and inventory to levels that are just adequate to meet the needs of production departments and customers.  Based upon the idealistic but practically difficult concept of zero inventories, JIT management involves complex and efficient coordination between purchasing and inventory departments and numerous suppliers, in order to ensure that material in stock, whilst kept at low levels is adequate to meet production and sales demands.  Whilst JIT management is a complex and demanding operational process and may not be suitable for items that are in short supply, have long manufacturing times, or are sourced from different locations, the implementation of JIT processes exposes purchasing and inventory managements of conservatively run manufacturing organisations to a range of concepts and ideas and leads to significant improvement in inventory and purchase management functions.  JIT involves the scrutiny of all inventory items, their classification in terms of importance, urgency, ordering time, source location, required quality, supplier availability, and a range of other variables, and enables organisational managements to effectively streamline buying and stocking processes, reduce inventory levels and free funds blocked in excess inventory. 
Kaizen, a Japanese process of continuous improvement, deals with making inventory management, especially so in manufacturing organisations with numerous inventory components, user friendly and manageable at the employee level through a range of stacking and colour coding techniques.  Modern day supply chain management integrates the process of material movement from the original source of material to the ultimate point of consumption, through the coordination and collaboration of various supply chain members, in order to ensure the most optimal inventory, manufacture, and logistics operations at all nodes of the supply chain.  The thoughtful incorporation of Kaizen, JIT and Supply Chain Management concepts can significantly help XYZ in optimising inventory processes and levels. 
Debtors constitute another important component of working capital. Efficient management of debtors involves coordination and participation of the senior management, as well as the sales, collections and finance functions.  Senior managers need to in the first case specifically detail the terms of credit that can be extended to buyers, considering various organisational objectives and needs.  Sales managers should ensure that credit terms provided to customers never exceed organisational norms without appropriate permissions.  Collection executives should ensure that due monies are collected within specified time frames through proactive measures.  Finance managers on the other hand need to make sure that information regarding debtors is accurate and up to date.  With sales essentially being a dynamic process requiring the involvement of internal managers and external consumers, concerned managers need to always be alert in order to ensure adequate control over debtors. 
Such controls over the asset components of working capital need to be accompanied by appropriate measures to ensure that the best possible terms and conditions of trade are achieved from creditors, care being taken to see that their payments are made in time.
Lastly organisations must ensure that the funds freed through effective management of debtors and inventories are not left in the form of unutilised cash but are invested appropriately in accordance with business objectives. It is only then that the efforts of efficient working capital management will finally bear fruit.