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. 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.
- @serenesurface– The article described in detail the advantages and disadvantages of both budgets.
- This variance is directly affected by the nature of expenses as well, which can be fixed or fluctuating in nature.
- Had the company prepared a flexible budget, the budget for sales commissions would be expressed as 5% of sales.
- Another way to mitigate the effects of a fixed budget is to shorten the period covered by it.
A budget that does not take into account any circumstances resulting in the actual levels of activity achieved being different from those on which the original budget was based. Consequently, in a fixed budget the budget cost allowances for each cost item are not changed for the variable items. Operational budget covers revenues and expenses which involve day to day core business of the organisation which is normal operation activities. The main elements of the organisation operational budget include sales, production, inventory, materials, labours, overheads and R and D budgets. 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.
Nonetheless consultants have the great level influences the senior management. The consultants are import and hired to fill competency gap in the organisation. As Drucker notes, “The executive works with same organisation or most with very few”. Consultant will able to transform the organisation and gain the exposure at the same time will add significant value by reducing the problem resolution cycle time (Hagedorn, 1982).
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 define fixed budget $50,000. If the actual sales end up being only $900,000 the budget for sales commissions will remain unchanged at the fixed amount of $50,000. If the actual sales are $1,100,000 the budget for sales commissions will also be $50,000.
The organisation main objective is to improve the performances while the consultants other goals such as knowledge acquisition and business growth. To overcome the situation, the organisation must well coordinate with consultants to achieve the desired goals. Had the company prepared a flexible budget, the budget for sales commissions would be expressed as 5% of sales. This means that the budget for sales commissions will be $50,000 only when sales are $1 million. If the company has actual sales of $900,000, the budget for sales commissions will flex and will be $45,000 (5% of $900,000).
It is more important for any organization to analyse the variances identified by flexible budgets due to the fact that flexible budget determines the standard cost of operating for actual output levels. 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. Since most companies experience substantial variations from their expected activity levels over the period encompassed by a budget, the amounts in the budget are likely to diverge from actual results.
What Does Fixed Budget Mean?
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. Finding the favorable or unfavorable variances between the actual and budgeted performance is one way that management can gauge the performance https://cryptolisting.org/ of a segment. This is why flexible or variable budgets are usually preferred to static budgets. They are able to corresponding with the actual level of output and revenues better than a static budget. Fixed budget also known as a static budget can be defined as a budgetary plan which remains fixed i.e. do not changes with the increase/ decrease in volume of input and output like sales, production units, activity level etc.
Disadvantages of Fixed Budgets
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. The disadvantage of fixed budget as it’s operates to one level of activity- the planned activity and it does not account for the business unpredictable activity.
The fixed budget is not effective for evaluating the performance of cost centers. Indentify level of activity that resource is most engaging and challenging which based on activity based costing. One of most important factor to take into account when hiring consultants was mentioned by Luo and Liberatore (2009) which examined consultant’s objective and goals.
Fixed budget approaches are widely adapted by service industry (Reeve and Warren, 2007) and partly by some administrative functions of manufacturing companies such as purchasing, engineering and accounting. If, the level of activities attained are varies from the budgeted activities then fixed budget become ineffective. A significant downfall to the flexible budget, however, is that it cannot be created until some sales figures have first been generated.
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. 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.
Given their simplicity, static budgets are easy to prepare and allow management to focus on operations instead of being consumed with analysis. An organisation hiring a consultant to bring as it will bring the required expertise, knowledge and experience to the organisation. Accordingly to Kelly (1979) hiring external consultant will be expensive as the payment will be based on their specialised skill in the respective field compare to internal consultant. An external consultant will not available at the right time and not easily accessible to the organisation as the internal executives. At the same time, and they are lack knowledge of organisation culture and working environment.
United Consultancy will be hiring consultant for preparation for future budget as it will bring new Idea, proficiency and impartiality objective (Gattiker and Larwood, 1985). 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. Majority of the cost drivers are related either to the level of activity or the complexity of the production or marketing process. Effectively planning to use the cost drivers in different level of activities.
Budget facilities the planning and resources allocation and help to estimate, itemised, analysis and examined the entire product and service that organisation offers to customer. Scott & Hascall (2002) had analysed the advantage and disadvantages of consultants and United Consultancy need to consider before hiring consultants for involving in preparation of future budgets. The advantage of fixed budget is to help the business to prioritise the expenses. Fixed budget clearly distinction between the businesses needs and wants by forcing the business to remain consistent, it will also ensure that the bills are paid on time. The aim of budgeting is to give management an idea how well the organisation is projecting the income goals and how well the organisation managing the working capital.