What are the differences between a fixed and flexible budget?
The following are the major differences between fixed budget and flexible budget:
- The budget, which remains constant, regardless of the actual output levels is known as Fixed Budget. ...
- Fixed Budget is static in nature while Flexible Budget is dynamic.
- Fixed Budget operates in only one activity level, but Flexible Budget can be operated on multiple levels of output.
What are fixed and flexible budgets?
Fixed budget is very simple and works on assumptions while the flexible budget is complex and works on real data. Fixed budgets are rigid as they cannot be modified as per the real outputs. Flexible budgets are elastic in nature and can change with the change in the volume of production.
What are the advantages of using a flexible budget vs. a static budget?
The greatest advantage that a flexible budget has over a static budget is its adaptability. In the real world, change is real and it is constant. A flexible budget can handle that reality and better position a company for the challenges of the marketplace.
What are the disadvantages of a budget?
What are the 5 disadvantages of budgeting?
- Requires time and tedious effort. It takes a lot of time and effort to figure out a realistic budget and maintain it. ...
- Limiting and restrictive. Budgeting limits and restricts our behaviors. ...
- Inaccurate. Budgets are a guessing game, and they can be inaccurate. ...
- Stressful. ...
- Not using the correct type of budget. ...
What is a fixed budget?
A fixed budget is a financial plan that is not modified for variations in actual activity. It is the most commonly-used type of budget, because it is easier to construct than a flexible budget.
What is fixed and flexible budget with example?
A fixed budget is a budget that doesn't change due to any change in activity level or output level. A flexible budget is a budget that changes as per the activity level or production of units. The fixed budget is static and doesn't change at all.
What is a fixed budget used for?
A fixed budget allows a business to measure both short-term and long-term budgets. The fixed budget allocates a set amount of money towards essentials such as overhead costs. Any money left over at the end of the month (or any other period you review your budget) is your profit.
What is flexible budget example?
This type of budget is most often based on changes in a company's actual revenue and uses percentages of revenue rather than static numbers. For example, a flexible budget may allot 25% of a company's revenue to salary as opposed to allotting $100,000 to salary in a given year.
What is the difference between fixed budget and variable budget?
Part of creating a budget is distinguishing between fixed and variable expenses: Fixed expenses: These are costs that largely remain constant, such as your monthly rent or mortgage. Variable expenses: These are costs that vary or are unpredictable, such as dining out or car repairs.
What is the difference between fixed budget and cash budget?
The importance of the cash budget lies in the fact that this tells an organization on how and when to plan for cash surpluses or deficits. Flexible budget is a budget in which the expenses adjust to the level of sales or output - in contrast, a fixed budget is one which does not vary with the level of sales or output.
How do you calculate fixed budget?
4:0711:39Fixed Budget [Profit on sales from total cost with prime cost] :-by kauserwiseYouTubeStart of suggested clipEnd of suggested clipSo what is the formula. Total amount divided by number of units fifty.MoreSo what is the formula. Total amount divided by number of units fifty.
What is a rolling budget?
With a rolling budget—also known as a continuous budget—you add a new budget period at the end of the most recent period. As a result, your budget always looks 12 months out (or however long of a horizon you set). With this approach, you never have to start building a budget from the ground up.
What are the types of budget?
Different types of budgetsMaster budget. A master budget is an aggregation of lower-level budgets created by the different functional areas in an organization. ... Operating budget. ... Cash budget. ... Financial budget. ... Labor budget. ... Static budget.
What is the difference between static and flexible budget?
Static vs Flexible Budgets Static Budget - the budget is prepared for only one level of production volume. Also called a Master budget. Flexible Budget - a summarized budget that can easily be computed for several different production volume levels. Separates variable costs from fixed costs.
How do you prepare a flexible budget example?
Formula or Ratio method In this method, the following formula is used for calculation: Flexible budget= Fixed cost + (actual unit of activity x variable cost per unit of activity). We can use any of these three methods to prepare the budget.
What are the fixed expenses in flexible budget?
Because fixed costs do not vary during the period in question, fixed costs behave the same in a flexible budget as they do in a static, or fixed, budget. This includes the traditional fixed costs of depreciation, occupancy costs, insurance and administrative personnel.
What is the difference between flexible and flexed budget?
A flexed budget is when the budget is rewritten for the actual level of activity. A flexible budget is one that is prepared for several different levels of activity.
Why do administrative functions have a fixed budget?
Administrative functions such as accounting and human resources may have a fixed budget as they are somewhat isolated from the short term effects of business volumes.
Why do teams have a fixed budget?
Teams with a fixed budget view the budget as a constraint and do what they can with their resources. This may encourage efficiency and productivity. However, a fixed budget may also result in missed opportunities or poor organizational performance if work volumes greatly exceed resources.
Is a fixed budget a constraint?
It is common for programs in the public and non-profit sector to be allocated a fixed budget for a year. This may represent a significant constraint if the program is addressing a large scale problem with a relatively small budget.
What is a Fixed Budget?
A fixed budget is a financial plan that is not modified for variations in actual activity. It is the most commonly-used type of budget, because it is easier to construct than a flexible budget.
How to mitigate the disadvantages of a fixed budget?
A good way to mitigate the disadvantages of a fixed budget are to combine it with continuous budgeting, where a new budget period is added onto the end of the budget as soon as the most recent budget period has been concluded.
What is the reverse of a fixed budget?
The reverse of a fixed budget is a flexible budget, where the budget is designed to change in response to variations in activity levels. There tend to be much smaller variances from the budget when a flexible budget is used, since the model tracks much closer to actual results.
Why are costs largely fixed?
Costs are largely fixed, so that expenses do not change as revenues fluctuate. The industry is not subject to much change, so that revenues are reasonably predictable. The company is in a monopoly situation, where customers must accept its pricing.
When is a fixed budget likely to track close to actual results?
The only situations in which a fixed budget is likely to track close to actual results are when costs are largely fixed, so that expenses do not change as revenues fluctuate, or when the industry is not subject to much change, so that revenues are reasonably predictable, or when the company is in a monopoly situation, where customers must accept its pricing.
Is a fixed budget effective?
The fixed budget is not effective for evaluating the performance of cost centers. For example, a cost center manager may be given a large fixed budget, and will make expenditures below the budget and be rewarded for doing so, even though a much larger overall decline in company revenues should have mandated a much larger expense reduction. The same problem arises if revenues are much higher than expected - the managers of cost centers have to spend more than the amounts indicated in the baseline fixed budget, and so appear to have unfavorable variances, even though they are simply doing what is needed to keep up with customer demand.
Is a fixed budget effective for evaluating cost centers?
The fixed budget is not effective for evaluating the performance of cost centers.
Definition of Fixed Budget
A fixed budget is a budget that does not change or flex for increases or decreases in volume. ("Volume" could be sales, units produced, or some other activity.) A fixed budget is also known as a static budget.
Example of Fixed Budget
To illustrate a fixed budget, let's assume that a company pays a 5% sales commission on all of its sales. If the company prepares a fixed budget and it is projecting sales of $1 million, the budget for sales commissions will be fixed at $50,000.
What is fixed budget?
Fixed budget, as the name suggests, remains fix even when there is a change in the business activity. Or, we can say, it is a financial plan that doesn’t get a modification with the variations in the business activities. We also call it a static budget.
Why is the fixed budget not relevant?
This is because businesses do witness a significant variation in activities than what they estimate initially. Thus, the budget is likely to be very different from the actual numbers. Because of this difference, there is a big variation between the budget and actual numbers.
Why should a company compare the variance of one budget period with the last one?
It should compare the variance of one budget period with the last one, to check if its estimates are getting better or not. If not, the company should try to change its estimation methods. Also, the company must review its past revenue and expenses to come up with a better budget.
How does reducing the period of a budget help?
Reducing the period of a budget can also help in making the budget more accurate. For instance, a budget for a period of three months will have less time to diverge from the estimates, than a budget for six months or a year.
What happens when the revenues are more than the expectations?
Similarly, if the revenues are more than the expectations, the cost center will have to spend much more than the budget. This will result in a massive variance even when the cost center was only working to catch up with the more demand.
What are the advantages of budgeting?
Such a budget offers a few advantages as well. They are very easy to prepare, and thus, give time to companies to focus on their core operations. Another advantage is that a company doesn’t need to make the changes every month.
Is a flexible budget a good idea?
Flexible Budget. A flexible budget is a very good alternative to a fixed budget. It addresses all the drawbacks of a fixed budget so as to make budgeting more accurate. In a flexible budget, we can adjust the budget numbers to reflect the changes in the business activity. Moreover, management can easily alter a flexible budget as per the needs ...
What is fixed budgeting?
Both fixed and flexible budgeting are ways to prepare a budget for your business or division. While one is rigid, the other is adjustable to your business’s output level (be it sales, units produced, or some other activity).
What is flexible budget?
By identifying the distinction between fixed, semi-fixed, and variable cost, a flexible budget is designed to change in relation to the activity attained. It is a budget prepared in such a way that it provides the budgeted cost for any level of activity.
What is the purpose of preparing a flexible budget?
To prepare a flexible budget, categories of cost must be examined individually in order to determine how different categories of cost respond to changes in volume. ( source)
What is fixed budget?
A fixed budget can be defined as a roadmap laid down by the management at the beginning of any financial period which draws an estimate of various activities like sales , production etc. along with required costs/ revenue figures.
How does a fixed budget work?
A fixed budget aids a business to attain optimal performance by checking revenues, sales and expenses. By comparing each departments performance with a fixed budget, identifying and analysingvariations, reasons for variations helps the organisation to achieve their financial goals in the long run. A fixed budget may be used by management like managers, chief financial officers and accountants in order to analyse and develop financial controls. It act as a system check tool that blocks overspending and tallies expenditure with revenue being generated from sales. A well-controlled fixed budget also aids in developing cash flow projections. In simple words, it can be said that a fixed budget is a planning tool that helps the organisation to monitor all the revenue being generated and all the expenses being incurred and thus helps in achieving its financial goals.
Why do managers use fixed budgets?
A fixed budget may be used by management like managers, chief financial officers and accountants in order to analyse and develop financial controls. It act as a system check tool that blocks overspending and tallies expenditure with revenue being generated from sales.
Why are variations identified and analysed with the help of flexible budget more important?
Variations identified and analysed with the help of flexible budget are more important as they provide details of operating efficiency/ inefficiency based on actual output.
What is the objective of a flexible budget?
Basic objective of flexible budget is to develop a standard level of costs which should be incurred for actual manufacturing outputs. A flexible budget is prepared taking into considerations nature of various cost incurred as like fixed or variable.
What is a well controlled fixed budget?
In simple words, it can be said that a fixed budget is a planning tool that helps the organisation to monitor all the revenue being generated and all the expenses being incurred and thus helps in achieving its financial goals.
What is a budget drawn based on?
Budget drawn based on historical data and management future assumptions which provides set guidelines for operations during the budgeted period.
What Does Fixed Budget Performance Report Mean?
This different between the actual and predicted performance numbers are called favorable or unfavorable variances.
Example
The fixed budget performance report’s purpose is to point out the areas where the company met the budget expectations and the areas where it failed to meet the predictions. This report gives management a powerful analytical tool to identify what parts of the business are performing well and what segments need more oversight.
What is fixed budget?
A fixed budget is a kind of budget where the income and the expenditure are Pre-determined. Irrespective of any fluctuation or change, this budget is static. Companies that are static, execute the same sort of transactions can significantly benefit from a fixed budget.
Why is fixed budgeting not an excellent method of budgeting?
Even if a fixed budget is elementary to prepare, ideally, it’s not an excellent method of budgeting to be precise; because fixed budgeting doesn’t leave room for fluctuations.
Which takes more time to prepare for a fixed budget or flexible budget?
The fixed budget takes comparatively little time to prepare. Flexible budget, on the other hand, takes a lot more time.
Why is there no change in the budget?
In case of the Fixed Budget there is no change in the budget of the company because of the change in the level of activity or the output level , whereas, in case of the Flexible Budget, changes happen in the budget of the company whenever there is any change in the level of activity or the output level. Cost Accounting Cost accounting is ...
Is a fixed budget static?
The fixed budget is static and doesn’t change at all. Flexible budget, on the other hand, is adjustable as per the necessity of the business. A fixed budget is always fixed. That means it is the same for any activity level. Flexible budget, on the other hand, is semi-variable.
Fixed Expense vs. Variable Expense
Unlike fixed expenses which do not change, a variable expense is an expense that changes from month to month. The amount you pay for a variable expense can vary depending on things like the season or your spending habits.
How Do Fixed Expenses Affect Your Budget?
Fixed expenses are important to track because they can have a big impact on your budget. They are the expenses that stay the same each month, while variable expenses change from month to month.
Paying Fixed Expenses
Fixed expenses cannot be avoided and must be paid regardless of how much money is left over after your variable expenses have been paid.
Importance of Fixed Expenses
Fixed expenses are important because they allow you to budget for a specific amount of money each month.
Ways to Reduce Fixed Expenses
Rent or mortgage – Consider downsizing to a smaller home or apartment to reduce your monthly payment.
Knowing Your Financial Habits
In order to reduce your fixed expenses, it is important to be aware of your spending habits. Track where you are spending your money each month and see where you can cut back.
Saving for Retirement
It is also important to save for retirement, even if your fixed expenses seem like a lot of money each month.
Example of Fixed Budget
Fixed Budget Variance
- Variance is basically the difference between the budget and the actual results. This variance plays a crucial role in measuring the performance of a business. A company using a fixed budget must focus on reducing this variance year after year. It should compare the variance of one budget period with the last one, to check if its estimates are getting better or not. If not, the company sh…
Advantages and Best Suited For
- There are a few scenarios when the fixed budget aligns closely with the real numbers. These are: 1. When the expenses are big and remain the same over time. 2. When the revenues are predictable. 3. If a firm enjoys monopoly power, and thus, cost and revenues get very predictable. 4. Suppose a firm exists in an industry where consumer demand doesn’t change much. Or the ch…
Drawbacks
- Following are the drawbacks of using such a budget: 1. Estimates are not accurate as it is very hard to correctly predict the demand and industry trends. 2. It doesn’t help when there is a need to allocate additional resources to keep up with the rise in demand. 3. This budget is based on past budgets. So, it gets tough for a new firm to prepare such a budget. 4. Since estimates are not ac…
How to Overcome Drawbacks?
- There are a few ways that can help a company overcome the shortcomings of a fixed budget. These ways are:
Final Words
- Even though a fixed budget has its advantages and we can overcome its drawbacks, its usage is very less in the real world. Moreover, many regard it as an ineffective tool to control costs. Such a budget suits only a few types of companies, such as those having monopoly power or operating in an industry with predictable demand. That is why most companies prefer to go with a flexible bu…