However, for larger and more complex businesses the use of a flexible budget is essential. For a small, simple business a static budget may be appropriate.
#Compare and contrast static and dynamic flexibility. how to
The key for management is to consciously make decisions on how to budget based on sound logic. Each will have different considerations, different business models, and individual uses for the budget.
Management could calculate that there are $3 in variable costs per unit produced, so an increase in production of 10,000 units will increase the budget by $30,000 for that month.Īs complex or as simple as management needsĮvery business will be unique in its budgeting needs. This is particularly common in manufacturing operations.įor example, if a factory has a larger than typical order for next month, the expense budget for that month could be based on the anticipated number of units to be produced. Other expenses will be tied not to a given revenue figure, but to a cost-per-unit calculation based on production levels. At $400,000, the marketing budget would reduce to $60,000. If revenue comes in lower than anticipated at just $400,000, then the marketing budget will automatically reduce based on that change in revenue. If the first quarter yields $500,000 in revenue, then the marketing budget will be 15% of that, or $75,000. For example, management may determine that marketing expenses should be equal to 15% of revenue each quarter. Variable expenses will be calculated based on other items that will be determined over time. With the fixed expenses taken care of, next management should turn to the variable expenses. Rent expense is an easy example to understand the logic. Remember, these expenses are what they are, and they're unlikely to change. This part of the process is identical to creating a static budget management should determine what those expenses will be and fill them into the budget as fixed items. To construct a flexible budget, the first step is to identify and budget for fixed expenses. How does the flexible budget actually work? In this way, the flexible budget is able to account for both fixed and variable expenses in a better, more responsive way than the simpler static budget could. The flexible budget solves this problem, providing both senior executives and middle management with dynamic guidance on how much to spend based on the business' changing reality. Management could, and most likely would, adapt to those changes, but at year-end there would be large budget variances that do not provide any analytical value to better plan for the following year. In a static budget, the company would not have the ability to tweak the budget to manage the changes if that large client contract doesn't materialize or if sales grow faster than anticipated. Or, if a sales and marketing plan works much more effectively than anticipated, then management should consider increasing the investment in those campaigns above what was originally budgeted. For example, a hiring plan may hinge on signing a large new customer to a long term contract. In either a flexible or static budget, the rent is what it is. It's unrealistic to expect that to change every month or even every quarter.
For example, a company's rent expense is likely fixed for the entire year. Not all line items in a budget can be flexible. Fixed versus variable expenses in a flexible and static budget.
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