Budgeting is a crucial aspect of financial management for both individuals and businesses. It involves planning and allocating financial resources to various activities and projects. Two common types of budgets used in this process are fixed budgets and flexible budgets. Understanding the differences between these two approaches is essential for effective financial planning and decision-making.
What is fixed Budget?
A fixed budget, also known as a static budget, is a financial plan designed based on a set level of activity. It remains unchanged regardless of actual performance or changes in the business environment. Fixed budgets are typically prepared for a specific period, such as a fiscal year, and are based on predetermined estimates of revenues and expenses.
What is flexible budget?
Unlike a fixed budget, a flexible budget is adaptable to changes in activity levels. It adjusts itself based on actual performance or changes in the business environment. A flexible budget allows for modifications in revenues and expenses, providing a more realistic financial plan that reflects the dynamic nature of businesses.
The following are the main difference between fixed and flexible budget.
Difference between Fixed Budget and Flexible Budget
| Fixed Budget | Flexible Budget |
| Fixed budget is inflexible and does not change with the actual volume of output achieved. | Flexible budget can be suitably recasted quickly according to level of activity attained. |
| Fixed budget assumes that conditions would remain static. | Flexible budget is design to change according to changed conditions. |
| Costs are not classified according to their variability i.e. fixed, variable and semi variable. | Coasts are classified according to the nature of their variability. |
| Comparison of actual and budgeted performance cannot be done correctly if the volume of output differs. | Comparisons are realistic as the changed plan figures are placed against actual ones. |
| It is difficult o forecast accurately the results in it. | Flexible budget clearly shows the impact of various expenses on the operational aspects of the business. |
| Only one budget at a fixed level of activity is prepared due to an unrealistic expectation on the part of the management | Series of budgets are prepared at different level of activities. |
| Fixed budget has a limited application and is inefficient as a tool for cost control. | Flexible budget has more application and can be used as a tool for cost control. |
| If the budgeted and actual activity levels vary, the correct ascertainment os coasts and fixation of prices becomes difficult. | Flexible budget helps in fixation of prices and submission of tenders due to correct ascertainment of coasts. |
Fixed Budget and Flexible Budget – FAQs
What is the difference between fixed budget and flexible budget?
A fixed budget is a financial plan that remains unchanged regardless of changes in business activity levels. It’s set for a specific period and doesn’t adjust for variations in sales or production. A flexible budget adjusts according to changes in the volume of business activity. It allows for variation in costs based on actual performance and can be more accurate in reflecting the true financial situation.
How do fixed and flexible budgets differ?
A fixed budget stays the same regardless of activity levels, while a flexible budget changes based on actual business performance and activity levels.
Why would a business use a fixed budget?
A fixed budget is straightforward and easy to prepare. It’s useful for stable business environments where activity levels don’t vary much.
Why would a business use a flexible budget?
A flexible budget provides a more accurate financial picture and helps in managing costs more effectively when business activities fluctuate. It’s useful for businesses with variable sales and production volumes.
Can a business use both types of budgets?
Yes, many businesses use both fixed and flexible budgets. A fixed budget can provide a baseline, while a flexible budget can offer insights into how changes in activity levels affect finances.
How is a fixed budget prepared?
A fixed budget is prepared based on expected levels of income and expenditure for a specific period. It involves estimating fixed costs and expected revenue without considering variations in activity levels.
How is a flexible budget prepared?
A flexible budget is prepared by identifying variable costs and adjusting them based on different levels of activity. It involves creating multiple budget scenarios for different activity levels.
When should a business consider switching from a fixed to a flexible budget?
A business should consider switching to a flexible budget if it experiences significant variations in sales, production, or other activities. This switch can provide a more accurate financial picture and better cost control.
Can a fixed budget be adjusted during the period?
Typically, a fixed budget is not adjusted during the period it covers. However, businesses may review and create a new budget if significant changes occur.
Is a flexible budget better for performance evaluation?
Yes, a flexible budget is often better for performance evaluation because it adjusts for actual activity levels, providing a more accurate comparison between budgeted and actual performance.
How often should a flexible budget be reviewed?
A flexible budget should be reviewed regularly, especially when there are significant changes in business activity levels. Monthly or quarterly reviews are common.
Can small businesses benefit from using a flexible budget?
Yes, small businesses can benefit from using a flexible budget, particularly if they experience fluctuations in sales or production. It helps them manage costs more effectively and adapt to changes quickly.