Difference Between Fixed and Flexible Budget

Article bySayantan Mukhopadhyay
Edited bySusmita Pathak
Reviewed byDheeraj Vaidya, CFA, FRM

Difference Between Fixed and Flexible Budget

The difference between the fixed and flexible budget lies in the way they change with respect to the changing costs. While in the case of the fixed budget, there is no change in the budget of the company because of the change in the level of activity or the output level, the flexible budget changes whenever there is any change in the level of activity or the output level.

Comparative Table

Basis for ComparisonFixed BudgetFlexible Budget
1. MeaningA fixed budget is a budget that remains static irrespective of the activity level.A flexible budget is a budget that changes as per the necessity of activity level.
2. What it’s all about?The fixed budget doesn’t change as per the fluctuations of business.Flexible budget changes as per the fluctuations of business;
3. Nature A fixed budget is always static.A flexible budget is very dynamic.
4. Simplicity Pretty simple.Quite complex.
5. Ease of preparationIt is easy to prepare a fixed budget.It is quite tough to prepare a flexible budget since one needs to prepare for all situations.
6. ConsequencesThe dissonance between the actual level and the budgeted level is quite high since there is no similarity in activity levelThe dissonance between the actual level and the budgeted level is quite low.
7. ComparisonComparison is difficult since the activity levels are different at the actual level and budgeted level.Comparison is quite easy since the activity levels are quite similar.
8. RigidityPretty rigid, no fluctuation is taken into account.Quite flexible, almost every fluctuation is taken into account.
9. How is it estimated?A fixed budget is mostly estimated on assumptions and anticipations.A flexible budget is prepared with realistic situations in mind.

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What Is A Fixed Budget?

A fixed budget is a kind of budget where the income and the expenditure are pre-determined. Irrespective of any fluctuation or change, this budget is static. Companies that are static and execute the same transactions can significantly benefit from a fixed budget. But wherever there are fluctuations, a fixed budget doesn’t turn out to be the most suited one.

The fixed budget once decided on does not change even if the business performances changes or the output gets changed. Such budgets are prepared for a year as the expenses and costs necessarily remain constant for at least those many months. This budget preparation takes into consideration different factors before determining the expected income and expenditure related to different business activities. Some of these factors include the sales volume and the fixed costs, like rented manufacturing unit or equipment, etc.

While preparing this budget is a simple affair, given the fixed costs involved in undertaking the calculations with respect to the business income, it lacks flexibility at the same time. No matter how positive the change in the sales volume of a business is, the budget would not undergo any change, even the minutest one.

Example

Suppose Bakers, a baking business unit, has prepared a fixed budget based on its expected sales volume and output at the start of the year. In the budget, it records the revenue as $80,000 along with the fixed expenditures, including the rent of the manufacturing unit, machinery prices, ingredients cost, and insurance premium worth $2500, $2000, $3000, and $1500, respectively. However, for the year, the sales volume moved up from 2000 units to 2600 units, above the expectations of the business. But as the budget was a fixed one with no provisions of further changes, the company remained stuck to the existing budget.

What Is A Flexible Budget?

Flexible budget is a budget that is flexible as per the needs of the hour. For example, if the company sees that it can sell off more of its products by expending more on advertising costs, a flexible budget would help execute that. That’s why a flexible budget is very effectiveA Flexible Budget Is Very EffectiveA flexible budget refers to an estimate which varies with the change in production activity or volume. Such a budget is more realistic and flares the managerial efficiency and effectiveness as it sets a benchmark for the actual corporate performance.read more for companies who go through many changes during a particular period. It is much more complicated than the fixed budget too.

As the name implies, this is the opposite of the fixed budget and it changes with the changes in the variables, including sales volume and output. It is prepared keeping in mind the changing costs and expenditures of a firm with respect to its changing sales volume and output. As a result, this budget is prepared more practically taking into consideration the current requirements and income of a business.

Being adaptive to the changes that take place in a firm and its sales volume, activities, and output, these budgets lead to more informed business decisions and guide the firms to undertake operations in sync with what the current company scenario is.

Example

A shoe making unit prepared a budget based on the expected sales volume and average output of the manufacturer. The sales revenue was recorded as $100,000 for the period with the raw material expenses, labor expenses, marketing and advertising expenses, and rent and utilities worth $3000, $3000, $2500, and $2000, respectively.

However, the new collection witnessed a significant rise in demand, thereby making the manufacturing firm involve more resources both materialistic and labor. Given the rise in the sales volume and significantly increased expected output, the shoemakers decide to increase their budget to $150,000 so that more labor and raw materials are utilized to manufacture more pairs of shoes.

This is how the flexible budget work by being open to changes based on the fluctuation market requirements or business requirements.

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