Difference Between Fixed Budget And Flexible Budget With Comparison Chart

By keeping each department or division within budget, companies can remain on track with their long-term financial goals. A static budget serves as a guide or map for the overall direction of the company. A static budget based on planned outputs and inputs for each of a company’s divisions can help management track revenue, expenses, and cash flow needs. When preparing a Flexible budget, managers are forced to consider the different scenarios and their responses to them. Thus, for a number of different situations, managers will have calculated their costs and revenues. If an unexpected event does occur, changing the level of activity, the management will be better prepared.

It sets the standard to measure the variances of the budget estimates and the actual performance of the company for control purposes. A budget variance measures the difference between budgeted and actual figures for a particular accounting category, and may indicate a shortfall.

Advantages Of Flexible Budgets

Operations managers that have limited or unplanned resources may not be physically able to adjust for revised activity levels or production. Management may also adjust sales prices to achieve the favorable variance as long as it doesn’t affect their competitive edge. Budgeting and variance analysis can help management to price their products at the optimal level while meeting Market competition and covering their production costs. Fixed and variable cost determination happens on an arbitrary basis. Hence flexible costs are less relatable to the correct budget cost of the level of activity.

In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity. A flexible budget that can be used to estimate what costs should be for any level of activity within a specified range. A flexible budget shows what costs should be for various levels of activity. These budgets are usually used for short periods or for smaller projects where the level of activity is pre-determined. Conditional budgeting is a budgeting approach designed for companies with fluctuating income, high fixed costs, or income depending on sunk costs, as well as NPOs and NGOs.

Regardless of the total sales volume–whether it was $100,000 or $1,000,000–the commissions per employee would be divided by the $50,000 static-budget amount. However, a flexible budget allows managers to assign a percentage of sales in calculating the sales commissions. The management might assign a 7% commission for the total sales volume generated.

In fact, we still managed to contribute more than $600 to savings, or could take it a little easy and spend some money on entertainment. Getting yourself into the habit of never spending more than $15 on coffee every month or going to happy hour for exactly two beers might be an excellent way to stay on financial track. Introducing flexibility can create confusion and break you from healthy patterns. This is the section that accounts for utilities, student loan payments, car payments and other fixed expenses that you can’t easily modify. Housing should occupy its own category; for renters, it will likely have little more than “Rent.”

Example Of A Flexible Budget

One approach is telling you on mathematical models, and the other on people. It sets a performance benchmark and allows continuous improvement by pinpointing strengths, weakness, opportunities, and threats.

To determine the flexible budget amount, the two variable costs need to be updated. The new budget for sales commissions is $10,500 ($262,500 sales times 4%), and the new budget for delivery expense is $1,750 (17,500 units times 10%). These are added to the fixed costs of $12,500 to get the flexible budget amount of $24,750. A budget report is prepared to show how actual results compare to the budgeted numbers. It has columns for the actual and budgeted amounts and the differences, or variances, between these amounts. On an income statement budget report, think of how the variance affects net income, and you will know if it is a favorable or unfavorable variance.

With flexible budgets, managers are constantly updating their projections and cost controls with current information. The most significant advantage of flexible budgets over static ones is the ability to adapt to changes in the real world. Nothing ever stays the same, and management has the responsibility to respond to unanticipated adverse conditions and to take advantage of unexpected opportunities.

A company Tech Blue co. estimates a total production capacity of 300,000 units. Direct material costs and labor costs per unit are $ 5.50 and $ 3.50 respectively. Additionally, the company offers sales incentives to the sales force on 5% of sales. What will be total cost of the unit production with a maximum utilized capacity of 85%? And if the company achieves lower efficiency of 75% production or higher 90% production capacity.

What Are The Advantages Of A Flexible Budget?

It makes managers cost conscious and helps them in identifying priorities in the overall interest of the organisation. Establishment of well defined responsibility centres or action points where operations are performed and financial transactions in terms of money take place. Performance Budgeting had its origin in U.S.A. after the Second World War. It tries to rectify some of the shortcomings in the traditional budget. In the traditional budget amounts are earmarked for the objects of expenditures such as salaries, travel, office expenses, grant in aid etc. Ask Any Difference is made to provide differences and comparisons of terms, products and services.

In brief, a flexible budget is a budget that distinguishes the behavior of fixed and variable cost that changes. And changes that happen with the level of activity attained, or change in the revenue or other variable factors.

Flexible budgets, which are budgets designed to direct management to areas of actual financial performance that desire attention. Managers can apply this same basic process to control important areas of performance such as quality or customer service. A functional budget, also known as an operating budget, is a budget which relates to specific functions within a business. Functional budgets are prepared for each function in a business and are part of the master budget of a business. More than one cost driver might be needed to adequately explain all of the costs in an organization, so flexible budgets may have multiple cost drivers.

For instance, if the budget covered the production of 1,000 units, but only made 600 units, then the flexible budget adjusts to account for only the 600 actual units. The flexible budget shows the budgeted items from the static budget, including the cost and the expected sales, compared to the actual results. They work well for evaluating performance when the planned level of activity is the same as the actual level of activity, or when the budget report is prepared for fixed costs. However, if actual performance in a given month or quarter is different from the planned amount, it is difficult to determine whether costs were controlled. A static budget is a type of budget that incorporates anticipated values about inputs and outputs that are conceived before the period in question begins. A static budget–which is a forecast ofrevenueandexpensesover a specific period–remains unchanged even with increases or decreases in sales and production volumes. However, when compared to the actual results that are received after the fact, the numbers from static budgets can be quite different from the actual results.

Static Versus Flexible Budgets

It is more sophisticated as it needs to be re-evaluated according to the needs at any time of the reporting period. A budget that shows how costs vary with different rates of output or at different levels of sales volume and projects revenue based on these different output levels.

• Unfortunately, real life doesn’t let everything stay the same.
• A static budget–which is a forecast ofrevenueandexpensesover a specific period–remains unchanged even with increases or decreases in sales and production volumes.
• Total Mfg Overhead$92,500$95,000$97,250$100,000A flexible budget can be prepared for any level of activity.
• The actual results are then compared with the forecast or planned budgets to analyze the variance.
• With static budgets, costs of operations and product profit margins are set at the start of the year, based on historical data.

An incremental budget is a budget that is prepared by the management of a business for the current year of the business based on the last year’s budget. Managers of a business can use budgets to plan for the business as a whole or to plan for specific responsibility centers, departments, functions, projects, or business units. The first school of thought believes that financial models if properly constructed, can be used to predict the future. The focus is on variables, inputs and outputs, drivers, and the like. Investments of time and money are devoted to perfecting these models, which are typically held in some type of financial spreadsheet application.

Note that, while we spent the mechanic money in January, we adjust our budget for it in February. This month we won’t hit our savings goal but by flexing the budget we did manage to keep the car accident from putting us into the red.

Rolling Budget: Advantages And Disadvantages

The company offers sales incentives to their sales force of 5% of sales. It consists of two parts – first is the fixed cost and fixed cost portion of the semi-variable cost. And the second is the variable cost and variable cost portion of the semi-variable cost. A flexible budget provides cost estimates at a different level of activity. Also, a vivid classification of the expenses to different categories of a fixed cost, semi-variable cost, and variable cost is necessary before preparing a budget. A static budget helps to monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance.

A static budget is a kind of budget in which the income and expenditure of the concerned body are pre-determined for the upcoming period. Even in thee case of any fluctuation of change in the predetermined numbers, it remains static i.e., the same. A budget that considers different levels of production or sales. A flexible budget makes different amounts available to departments depending on what production or sales are realized. For example, a flexible budget may make 6% more money available to its research and development department if its revenue increases 6%. The flexible budget model only makes it possible to compare actual expenses and budgeted expenses.

Flexible budgeting allows you to adjust your savings and spending based on how you actually live your life, not based on a hypothetical sketch of how you should live it. These points make the flexible budget an appealing model for the advanced budget user. However, before deciding to switch to the flexible budget, consider the following countervailing issues.

Production Budget

The activity level here may refer to different cost drivers affecting the variable costs such as labor hours, direct materials, or sales commission, etc. Flexible budgeting performance report analyzes actual results against the standard budgets. If you have a positive variance, the company produced favorable results and achieved more than it had originally planned. And adverse or negative variance means the organization was not able to achieve its target plans.

A budget created at the beginning of the budgeting period that is valid only for the planned level of activity. Flexibility budget – it is established for fixed cost and variable rate is determined per activity measure for variable cost. Establishment of each responsibility centre and a programme of expected performance in physical units of that centre. A flexible budget is very useful for purposes of budgetary control because it corresponds with changes in the level of activity. Variance analysis in absolute figures cannot reveal the actual causes. The management may also adjust sales prices to achieve the favorable variance provided it doesn’t affect the competitive edge.

Chapter 9: Flexible Budgets & Performance Analysis Accounting Terms

A great deal of time goes towards formulating fixed cost components and developing cost formulas that might not work in the end. We can calculate the flexible budget performance flexible budgeting definition report based on different production level. As with any budget, flexible budgets are simply forecast that may change by the time production actually begins.