Flexible vs Static Budgeting
December 10, 2021
The importance of proper budgeting for an organization cannot be understated. Budgeting identifies currently available capital, provides an estimate of expenditure, and anticipates incoming revenue (Banks,2018). Businesses can measure performance against expenditure with a proper budgeting system and ensure that resources are available for programs or expenditures that support business growth and development. It enables the business owner to concentrate on cash flow, reduce costs, improve profits, and increase investment returns (Banks, 2018). A business can use two main types of budgeting: flexible budgeting and static budgeting. Each system has its pros and cons, so the decision should be carefully considered.
When deciding which type of budget system to use, the type of business the organization operates in and the business's goals should be considered. As stated above, there are pros and cons to each of the flexible and static budgeting systems, so choosing the one that works best for your organization is essential. When looking at each system more closely, we can gather when it is appropriate to use each one.
The flexible budget system adjusts based on changes in actual revenue or other activities. The result is a reasonably aligned budget with actual results (Bragg, 2021). The flexible system, in particular, uses percentages of revenue for certain expenses rather than the usually fixed numbers. This allows for an infinite series of budget changes that are directly tied to actual revenue incurred(Bragg, 2021).
One issue with the flexible approach is it can be challenging to formulate and manage appropriately. The maintenance involved in a constantly changing system can be very demanding. This maintenance may require a larger team of accountants, which raises the costs of accounting for the entire organization. Furthermore, the flexible approach tends to ignore changes to other expenses that do not change following small revenue variations(Bragg, 2021). Incorporating step costs may compensate for variations but adds more work and oversite to the budgeting process.
The static budge system varies from the flexible system in that it contains nothing but fixed expense amounts that do not vary with actual revenue levels. 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 (Kagan, 2021). A static budget–a forecast of revenues and expenses over a specific period–remains unchanged even with increases or decreases in sales and production volumes(Kagan, 2021). The static budget helps monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance (Kagan, 2021). A problem with the static budgeting system is that it cannot forecast the organization's needed expenses and operating revenue for any given upcoming period.
Proper budgeting is vital for any organization, no matter how big or small. The static budget system may be more effective for organizations with highly predictable sales and costs for shorter-term periods—the flexible budgeting system good tool for evaluating the need for a quick change or pivot. An organization might use a flexible budget system if additional raw materials are needed as production volumes increase due to seasonality in sales or if temporary staff is needed during certain times of the year. The best practice is probably for an organization to use both systems as appropriate as both systems can offer great insight into a companies performance and outlook.
Banks, K.(2018, February 28). The Importance of Budgeting in Business: WLF Accounting& Advisory. WLF Accounting & Advisory |.https://wlf.com.au/importance-budgeting-business/.
Bragg, S.(2021, April 16). Flexible budget definition. AccountingTools.https://www.accountingtools.com/articles/what-is-a-flexible-budget.html.
Kagan, J.(2021, May 19). Static Budget. Investopedia.https://www.investopedia.com/terms/s/staticbudget.asp.