Flexible budgets offer better control over business processes and can better predict future demands, but may require a more sophisticated accounting department. A combination of static and flexible budgets is often used in publicly traded companies. Choosing the appropriate budget type depends on the business cycle, expenses, and level of variance. Flexible budgets provide real-time data for cost control, but may initially be based on last quarter’s static budget.
A flexible budget tends to more accurately represent both the cash flow requirement in a business and the projected sales profit compared to a static budget. However, static budgets are known to be much simpler to manage and are usually created before the production process begins in a company. Since a flexible budget attempts to adapt to changing resource levels in inventory and consumption, it offers a finer level of control over business processes than a static budget. Variable budgets also tend to better predict future business demands and adjust for unexpected external factors that can affect productivity.
Whether a business uses a flexible budget or a static budget largely depends on the nature of the business cycle and the season. The sophistication of the accounting department in handling the more complex task of managing a dynamic budget is also important in determining whether frequent and unexpected changes can be adequately addressed. In publicly traded companies, a combination of both approaches is often used. An annual static budget is produced to provide analysts and investors with a predictable direction for the company, and short-term flexible budgets are also created, either quarterly or monthly, to accommodate changing market conditions as they arise.
Choosing the appropriate types of budgets for businesses also depends on how large the level of variance is in terms of increased or decreased profits. This variation is also directly affected by the nature of the expenses, which can be fixed or fluctuating. A static budget approaches variance by trying to work with excess resources ahead of time to catch potential changes in demand in the future, and therefore can lead to inventory issues. A flexible budget, on the other hand, is only created once the actual sales volume is known, which greatly reduces variance issues, such as inefficiencies in available labor, but, at the same time, makes make flexible budgeting 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 vs. actual product vs. cost results and efficiencies in managing costs. This means that it offers much greater cost control over a business operation and makes it more competitive. This also targets more accurately when performance levels are below expectations. One approach that larger companies take to deal with such variables is to have a static budget for the overall organization and a flexible budget for each individual department.
However, one major downfall of the flexible budget is that it cannot be created until some sales figures have been generated. This means that a flexible budget is initially based on the performance levels of the last quarter’s static budget. Therefore, using a flexible budget for the first time can cause some problems in providing the right amount of resources to meet current needs. Sections of a business that are growing rapidly may be underfunded while others are overbudgeted until data accumulates and flexible budgets become more accurate to track and support ongoing trends. This is superior to using a static budget alone, which can lead to business losses due to a lack of mobility to be able to purchase new equipment when unexpectedly needed or to properly channel capital into underperforming or overperforming sectors.
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