Pros and cons of static and flexible budgets

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Pros and cons of static and flexible budgets

pros and cons of static and flexible budgets

Budgets play a key role in helping companies track their finances, analyze their expenses, and identify ways to maximize their profits. A static budget is one that remains constant even as other factors, such as sales volume and revenue, change.

A flexible budget, by contrast, is one that adjusts based on changes in revenue or other sales activities. How static budgets work A static budget is based on a company's anticipated level of output and revenue at the start of the accounting period it's designated to cover. Static budgets are typically based on data that is collected and analyzed before the budget period begins.

Once a static budget is established, a company will follow it but also keep track of its actual spending, paying close attention to any type of budget variance that pops up.

Static Budget Vs. Flexible Budget

A budget variance is the difference between the original budgeted amount of expense or revenue, and the actual amount of expense incurred or revenue generated during the accounting period in question.

If a company brings in higher revenues than its static budget plans for, the variance is considered a favorable one. Advantages of static budgets One major advantage of the static budget is that it's easy to implement and follow, as static budgets do not need to be updated continuously throughout the accounting periods they're intended to cover. Additionally, a static budget can offer strong insight into a company's costs and profits when a variance analysis is performed. This allows a company to see where it might be overestimating or underestimating its expenses and revenues so that it can make changes or alter its strategy going forward.

Also, because static budgets don't have built-in wiggle room, they can help companies control their costs and make smart spending decisions. Disadvantages of static budgets The greatest disadvantage of the static budget is its lack of flexibility.

If a company establishes a budget based on a certain level of sales volume and that volume increases, it can't allocate additional resources to keep up.

Along these lines, if a company identifies underperforming areas of the business, it can't allocate additional resources to help. This, in turn, can negatively impact a company's revenue stream. Furthermore, because static budgets are based on previous data, newer businesses may have more difficulty establishing and implementing them. Static budgets are generally most useful for companies with highly predictable sales volume and costs, whereas companies that experience greater year-to-year fluctuations can't use static budgets as easily.

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Key Advantages & Disadvantages of Using a Static Budget

Thanks -- and Fool on! Mar 14, at AM. Stock Advisor launched in February of Join Stock Advisor. Next Article. Prev 1 Next.Learn something new every day More Info A fixed budget is a financial document that remains the same throughout a financial period, regardless of any unexpected and spontaneous events that may transpire. Flexible or variable budgets, on the other hand, change from time to time based on changes in expenditures.

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The benefits to a fixed budget include greater stability, better savings, and easier future planning, while the disadvantages include reduced flexibility. Possibly the biggest drawback to fixed budgeting is that it does not allow an individual or business owner to adjust the budget based on a change in situation, such as the loss of a job or reduced profits.

This makes it especially hard to react to the type of unexpected changes that typically occur in the business world, as well as life in general. For this reason, most large conglomerates prefer flexible budgeting to fixed budgeting.

Small business owners typically prefer fixed budgets, however, because they provide a much greater level of stability and spending control. Fixed budgeting entails establishing a maximum spending limit, meaning that the individual or business owner may not spend past this point.

This is beneficial because it prevents one from overspending on a whim.

pros and cons of static and flexible budgets

Another benefit to a fixed budget is that it would force a person to direct that bonus into his savings account. With a flexible budgethe could decide to allocate it toward a spontaneous purchase, such as a high-definition television or laptop.

He must in fact wait until the next fiscal year, at which point he can adjust the budget by increasing the allowed amount of discretionary spending. The largest benefit to the more controlled spending and improved savings that result from a fixed budget is greater future planning. That extra money put away into savings could become extremely important if an accident were to occur. Or the person may marry, have a child, and suddenly realize that he and his wife need to establish a college fund.

A fixed budget is an optimal choice for small business owners and individuals. It provides a level of stability and control that cannot be found in a flexible budget.

There are pros and cons of both fixed budgets sometimes called "static budgets" and flexible budgets. Which budget is best for a business or individual depends on the circumstances and nature of that business. And it doesn't always have to be an either or decision. Many businesses use both fixed and flexible budgets to benefit from both. For individuals, of course, it's slightly different. If for example, one has a business with highly varying volume, costs and revenue, a fixed budget becomes impractical.

With a flexible budget, it's necessary to way for the numbers because this is not a budget that can be made with a prediction. On the other hand, a fixed budget with the predicted costs and profits can be prepared before the term is over. This is also a great way to make comparisons between expected costs and real costs when the next term begins.

Post your comments Post Anonymously Please enter the code:. One of our editors will review your suggestion and make changes if warranted. Note that depending on the number of suggestions we receive, this can take anywhere from a few hours to a few days.A static budget is a company budget that does not change as sales change.

Static budgets are set in advance and are based on information about profit and expenses collected before the budget period begins. A static budget has a number of uses for data collection and analysis and is often used together with a flexible budget to make comparisons between predicted sales and costs and actual sales and costs. One key advantage of a static budget is that it is easy to develop and use. This is because a static budget does not need to be adjusted as sales volume and turnover change.

When using a static budget, you simply calculate costs and estimate total sales over the period of the budget — generally 12 months. At the end of the budget period, determine actual costs and revenue and use this information to prepare the next budget. This may be particularly useful for a small business, because it allows those without much business experience or expertise to develop a budget. A static budget also can make it easier to estimate taxes owed. This is a big advantage for small companies, where the owner-operator may be performing some of the accounting functions.

Small companies often make estimated tax payments on a quarterly basis to avoid making interest payments on money owed.

A static budget allows companies to estimate the total taxes owed and set aside the right amount each quarter.

Static vs. Flexible Budgets

Larger companies may use a static yearly budget and flexible monthly or quarterly forecasts, to allow for more accurate tax reporting. For larger businesses, a key advantage of static budgets is that they are often used as a master budget.

Master budgets are useful in data analysis and forecasting. A static budget will be prepared for the entire business, and a flexible budget is then prepared for each division or department in the company. The static budget can then be used as the basis for variance analysis.

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In variance analysis, the actual results are compared with those in the static budget. If the variance is unfavorable -- in other words, if the revenue is less than in the static budget -- the analyst knows that next year's budget will need to decrease. Similarly, if the variance is favorable, the next year's budget can be larger. One key disadvantage of a static budget is that it is not flexible and so it cannot be changed to take advantage of changes in revenue or expenses as the year proceeds.

With a static budget, companies cannot manage the impact of changes, for example, by decreasing a portion of the budget in response to slow sales. This translates into a lack of control of budgeting functions.Your small business needs an overall operating budget to survive. As your company grows, each department will also need separate budgets to meet costs and complete objectives. Implementing a system using flexible and static budgets can provide the advantages of controlling your business' departmental finances while still allowing the mobility necessary to meet the unexpected challenges and opportunities of the business world.

A flexible budget allows you as a business owner to compare how your company's actual sales figures stack up against expected sales figures. For example, a flexible budget for a restaurant may have performance expectation figures based on guests, guests and guests served in a night.

What Are the Advantages and Disadvantages of Using a Static Budget?

This can be a partial indicator of your company's overall level of performance and can be a sign of overachieving or under-performing, depending on the numbers. Your small business cannot prepare a flexible budget until the end of a financial quarter. As such, a flexible budget depends on hindsight to adjust your company's financial expectations and can do nothing to help you adjust the performance or sales of the quarter that just passed.

In essence, your small business must fly blind for a quarter before you can collect sufficient data to adjust your expectations for future fiscal quarters. A static budget does not adjust its volume during the year regardless of sales figures or company performance. The cap on your company's budget helps your business control its costs and provides a level of certainty for your finances. This allows you to maximize your savings and ensure your company is spending every penny as wisely as possible.

The strength of a static budget is also its greatest weakness. The lack of mobility in your budget lines means you won't have the ability to allocate resources to prop up under-performing areas of your business, provide additional capital in the event of equipment failure or seize a new market opportunity. This can lead to a drag on your revenue stream that cause your company to operate at a loss for the year.

A company that's losing money can cause a snowball effect where investors choose other business opportunities, further exacerbating your diminished funds. Jonathan Lister has been a writer and content marketer since Skip to main content.

Comparing the Numbers A flexible budget allows you as a business owner to compare how your company's actual sales figures stack up against expected sales figures. Dependence on Hindsight Your small business cannot prepare a flexible budget until the end of a financial quarter. Controlling Business Costs A static budget does not adjust its volume during the year regardless of sales figures or company performance. Lack of Budget Mobility The strength of a static budget is also its greatest weakness.

About the Author Jonathan Lister has been a writer and content marketer since Accessed 11 April Lister, Jonathan. Small Business - Chron. Note: Depending on which text editor you're pasting into, you might have to add the italics to the site name.Budgets help keep you on track financially if used properly. When you set up a budget, you can choose between the two main budget types -- flexible and static.

pros and cons of static and flexible budgets

Although most individuals and businesses use a flexible budget at some point, static budgets have notable benefits. In some circumstances, they are the better budget choice. A static budget is a budget in which allotments do not change over the course of a budget period. It does not take changes in expenses or income into account. Even though a static budget doesn't change, like a flexible budget, static budgets may cover many different areas, such as utilities, rent or food.

With a static budget, the numbers with which you work are constant. This can make it easy to plan and investigate financial options. Under this method, you can't really tell what you'll be able to afford from one month to the next. This makes it easy to predict what you can do. Static budgets don't accommodate fluctuations in costs or revenue. Some consider this blindness to current markets as a limitation in static budgets, since your actual income and expenditures often vary from your budget projections.

However, because static budget variances force you to be aware of where your budget was inaccurate, they let you easily monitor market trends. Over time, if you review the trends, you can make predictions about what may happen in the future and make the budget for the next static budget cycle more accurate.

With a flexible budget, you constantly have to reassess and come up with additional or new figures. With a static budget, this really isn't necessary. You may end up spending less time working on the budget. Some experts such as Jerry J. Weygandt, Paul D.

Kimmel and Donald E. Kieso propose that there really isn't a lot of difference between a static budget and a flexible budget. In this sense, flexible and static budgets are connected, and despite the limitations of a static budget, you should see a static budget as a foundation for flexible methods.

Wanda Thibodeaux is a freelance writer and editor based in Eagan, Minn. She has been published in both print and Web publications and has written on everything from fly fishing to parenting.

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She currently works through her business website, Takingdictation. Share It. About the Author. Photo Credits.Without determining the proper amount to save and spend each month, it can be easy to fall into credit card debt or incur other adverse financial penalties.

What are the Pros and Cons of a Fixed Budget?

For those who fluctuate in monthly expenditures, flexible budgeting can be a great solution but there are also some drawback to this practice.

These are examples of seasonal expenses that do not recur throughout the year. Flexible budgeting can be used to adjust for these large purchases when they occur without requiring any adjustments in following months. Irregular Earnings Holiday bonuses often recognize a year of work but they also come at a convenient time.

Many families have increased expenses at this time of year which is also why many employers choose to give out bonuses when they do.

pros and cons of static and flexible budgets

Flexible budgets incorporate these irregular payouts in a way that allows them to be used when the funds are most needed. Less Stress, More Fun Budgets are helpful but they can also become oppressive if an individual consistently cannot stay within the limits or passes on opportunities in order to save money. Just be sure not to use it an excuse to lose the boundaries entirely. Confusing Budgets are simple because they provide one figure within which someone must remain. Flexible budgets require more planning in order to track expenses and adjust for any differences between periods.

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. 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. 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.

Advantages of Flexible Budgeting 1.

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Disadvantages of Flexible Budgeting 1. Share Pin Tweet.A flexible budget is one that is allowed to adjust based on a change in the assumptions used to create the budget during management's planning process. A static budget, on the other hand, remains the same even if there are significant changes from the assumptions made during planning. 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. Fixed versus variable expenses in a flexible and static budget. Not all line items in a budget can be flexible. For example, a company's rent expense is likely fixed for the entire year.

It's unrealistic to expect that to change every month or even every quarter. In either a flexible or static budget, the rent is what it is. Other expenses though are not so simple. For example, a hiring plan may hinge on signing a large new customer to a long term contract.

Or, if a sales and marketing plan works much more effectively than anticipated, then management should consider increasing the investment in those campaigns above what was originally budgeted. In a static budget, the company would not have the ability to tweak the budget to manage the changes if that large client contract doesn't materialize or if sales grow faster than anticipated. Management could, and most likely would, adapt to those changes, but at year-end there would be large budget variances that do not provide any analytical value to better plan for the following year.

The flexible budget solves this problem, providing both senior executives and middle management with dynamic guidance on how much to spend based on the business' changing reality. In this way, the flexible budget is able to account for both fixed and variable expenses in a better, more responsive way than the simpler static budget could.

How does the flexible budget actually work? To construct a flexible budget, the first step is to identify and budget for fixed expenses. This part of the process is identical to creating a static budget; management should determine what those expenses will be and fill them into the budget as fixed items.

Remember, these expenses are what they are, and they're unlikely to change. Rent expense is an easy example to understand the logic.

With the fixed expenses taken care of, next management should turn to the variable expenses.

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Variable expenses will be calculated based on other items that will be determined over time. Other expenses will be tied not to a given revenue figure, but to a cost-per-unit calculation based on production levels. This is particularly common in manufacturing operations. For example, if a factory has a larger than typical order for next month, the expense budget for that month could be based on the anticipated number of units to be produced.

As complex or as simple as management needs Every business will be unique in its budgeting needs.


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