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What Are the Pros and Cons of a Flexible Budget?

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  • Written By: Ray Hawk
  • Edited By: E. E. Hubbard
  • Last Modified Date: 05 September 2016
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A flexible budget tends to more accurately represent both the requirement for input cash flow into a business, as well as projected sales profits as compared to a static budget. Static budgets, however, are known to be much simpler to manage and are usually created before the production process in a company even begins. Since a flexible budget tries to adapt to changing resource levels in inventory and consumption, it offers a more precise level of control over business processes than a static budget can. Variable budgets also tend to be better at predicting future demands for the business and adjusting for unexpected external factors than can affect productivity.

Whether a flexible budget or static budget is used by a business is largely determined by the nature of the business cycle and how seasonal it may be. The sophistication of the accounting department to handle the more complex task of managing a dynamic budget is also important in determining whether any frequent and unexpected changes can be properly addressed. In publicly-traded companies, often a combination of both approaches is used. A yearly static budget is produced to provide analysts and investors with a predictable direction for the company, and shorter-term flexible budgets on either a quarterly or monthly basis are also created to adapt to changing market conditions as they arise.

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Choosing the appropriate types of budgets for businesses is also dependent on how great the level of variance actually is in terms of increased or decreased profits. This variance is directly affected by the nature of expenses as well, which can be fixed or fluctuating in nature. A static budget approaches variance by trying to work in excess resources beforehand for any possible changes in demand down the road, and can therefore lead to issues with inventory. A flexible budget, on the other hand, is only created once the actual sales volume is known, which greatly reduces problems with variance such as inefficiencies in available labor, but, at the same time, makes the flexible budget a more immediate and critical concern for day-to-day operations.

One of the key advantages of flexible budgeting is that it provides management with real-time data on projected versus actual outcomes in product versus costs and efficiency levels in managing them. This means that it offers much greater cost control over a business operation and makes it more competitive. This also targets more accurately where performance levels are falling below or meeting expectations. An approach that larger companies take to dealing with such variables is to have a static budget for the overall organization, and a flexible budget for each individual department.

A significant downfall to the flexible budget, however, is that it cannot be created until some sales figures have first been generated. This means that a flexible budget is initially based on the performance levels of a past quarter's static budget. Using a flexible budget for the first time may therefore cause some issues with providing the right amount of resources to meet current needs. Rapidly-growing sections of a company may be underfunded, while others are over budgeted until data accumulates and flexible budgets become more accurate at tracking and supporting ongoing trends. This is superior to using a static budget alone, which can lead to business losses due to a lack of mobility in being able to buy new equipment when unexpectedly needed or to properly channel capital to under- and over-performing sectors.

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Discuss this Article

turquoise
Post 3

@stoneMason-- I actually disagree. Small business have less revenue than large businesses and it's even more important for them to get their costs and profits right because the risks are greater. A flexible budget, unlike a static one, gives real numbers that tells the business exactly how it's doing and what it can do better. So I think it's even more important for small businesses to use a flexible budget.

stoneMason
Post 2

@serenesurface-- The article described in detail the advantages and disadvantages of both budgets. I think that this is a decision that each business has to make based on its revenue, expenses and how predictable these are. If you know what your fixed and variable costs are and if you know exactly how your expenses are going to change in the near future, then a flexible budget will work for you.

If you don't know these and if you don't have the time or intention to update your budget frequently, then it's best to go with a static budget. Of course, if you have the means in the future, you can use both budgets to benefit from their advantages. But I think that for a small business that's just starting out, a static budget will work.

serenesurface
Post 1

Which type of budget is best for a small business that's just starting out? I think that a static budget will work just fine but this article has also made me aware of the downsides of this type of budget.

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