If actual output varies from budgeted level of output, variances will come up. Under flexible budgeting, series of fixed budgets are prepared for different levels of activity. Costs are not classified according to their variability i. Try any of our Foolish newsletter services. A range that changes over time can make the budgeting processing overly confusing for some users and therefore reduce the odds that they will successfully follow it. For example, consider a web store that downloads software to its customers; a certain amount of expenditure is required to maintain the store, and there is essentially no cost of goods sold, other than credit card fees.
The underlying flexible budget definition is that, a budget is of little use unless cost and revenue are related to the actual volume of production. However, in practice, fixed budget is rarely used. This is the budget facilitates not only to have comparison in between various levels of production but also to identify the level of lowest production cost. Static budgets allow investors to analyze any divergence between the forecasted budget and actual expenditures; a situation known as the static budget variance. The flexibility involved in this budget makes a very useful decision-making tool for management. For example, if actual production is 12,000 units in place of the budgeted 10,000 units, the costs incurred cannot be compared with the budget which relates to different levels of activity. Planning or budgeting for a range of activity rather than for a single level of activity is always preferable due to the uncertainty involved in forecasting future events accurately.
As complex or as simple as management needs Every business will be unique in its budgeting needs. Flexible budget is pretty complex. Fixed Budget is best suited for the organisations where there are fewer chances of fluctuations in the prevailing conditions or if the organisation is not influenced by the change in the external factors and the forecasting can be done easily to give close results. In addition to variable costs, flexible budgeting also takes into consideration fixed costs. Where nature of business is such that sales are difficult to predict e.
Wright has been writing since 2007. It can be seen the impact of changes in sales and production levels on revenue, expenses and ultimately income. Fixed budgets are more suitable for businesses that operate in a less dynamic business environment, whereas flexible budget are best for firms that operate in a turbulent market. In either a flexible or static budget, the rent is what it is. A sophisticated flexible budget will change the proportions for these expenditures if the measurements they are based on exceed their target ranges. If the budgeted and actual activity levels vary, the correct ascertainment of costs and fixation of prices becomes difficult.
This budget has a limited application and is ineffective as a tool for cost control. Any money left over at the end of the month or any other period you review your budget is your profit. The model is designed to match actual expenses to expected expenses, not to compare revenue levels. In short, a flexible budget requires extra time to construct, delays the issuance of financial statements, does not measure revenue variances, and may not be applicable under certain budget models. Facilities are provided to achieve budgetary goals, and funds are made available for the investments necessary to have higher output. That means it is same for any activity level.
Fixed Budget is a budget that remains constant, irrespective of the levels of activity, i. Within budget limitations, a company must balance the needs for variable costs with fixed costs. Flexible budgets provide businesses with various advantages. Flexible budgets are time consuming and because of constant change, become difficult to maintain. Flexible budgets complicate things by include more rules that can easily be bent or broken by someone who is struggling to stay within the boundaries.
Each will have different considerations, different business models, and individual uses for the budget. Where sales are affected by changes in fashion e. Less Discipline The whole point of a flexible budget is to make it easier to adhere to, however, by not following the same rigid program every month, such systems are unlikely to foster the same discipline or long term habits as more traditional alternatives. Disadvantages of Flexible Budgeting The flexible budget at first appears to be an excellent way to resolve many of the difficulties inherent in a static budget. When creating the variable cost portion of the budget, companies create a variety of potential cost values based on various market conditions, such as ideal, expected, worst case and more.
Changes Within the Limits of the Budget A fixed budget only works if a business can survive on it. To construct a flexible budget, the first step is to identify and budget for fixed expenses. Definition of Flexible Budget Flexible means easily adjustable, and Budget refers to an anticipated plan made for the financial activities of the entity. Determining the cost behaviour patterns fixed, variable, semi-variable for each element of cost to be included in the budget. In its simplest form, the flex budget uses percentages of revenue for certain expenses, rather than the usual fixed numbers. Fixed budget is prepared on the assumption that sales and output could be estimated with a good degree of accuracy.
A possible disadvantage of this form of budgeting is known to be the fact that they may be complicated to prepare, especially when the scenarios being considered are numerous in number, and complex in nature. Steve recomputes variable costs with the assumption that the company makes 125,000 units. But with a flexible budget, the budget manager knows how things are going throughout the term and can make changes to the budget along the way for the most realistic picture. A fixed budget is much easier to prepare than a flexible budget since it does not require constant revision, whereas flexible budgets are much more complex since the scenarios considered are greater in number. Flexible budgets are mostly preferred by firms because they allow the firm to conduct scenario planning and better adjust for unexpected situations. Flexible budget is very dynamic. This comparison gives you immediate insight into which months have better cash flow and the reason for that.
Disadvantages of Flexible Budgeting 1. Further, readjustment of how money is spent within the fixed budget can also cover costs of unexpected expenses while reducing spending in other, less urgent areas. To compute the value of the flexible budget, multiply the variable cost per unit by the actual production volume. Keeping Costs Down The fixed budget inevitably keeps costs down so long as the business abides by the strict financial limits placed upon the entire business. A fixed budget allows a small business to keep track of such unexpected expenditures by putting money aside specifically for these situations. The result is a that is fairly closely aligned with actual results.