A budget is a type of financial statement that businesses use in order to manage their day-to-day financial position. There are generally two types of budgets, a current or projected budget and an actual budget. The projected budget apprehends futures costs and cash flows, creating a schedule of costs to be followed as the company embarks on a particular project or month of operations. An actual budget looks into the past, tallying the costs that actually occurred and comparing them to the original, predictive budget to judge for accuracy. A flexible budget is a hybrid projected budget that you can use in projects where uncertainty plays a factor.
Fixed and Variable Costs
Budgets are typically divided into both fixed and variable costs, an important distinction for flexible budgeting. Fixed costs do not change based on the project or amount of production or sales. For instance, licensing fees do not change in response to business activity -- maintenance expenses and payroll are also relatively stable. But variable costs move up and down compared to activity. Cost of sales, commissions and shipping costs all change based on how much is sold. Many budgets are static and assume stationary variable costs, but flexible budgets make room for variable changes.
Moving Costs Up
When revenues increase, flexible budgets also allow costs to increase. In many ways this is a fair arrangement. For instance, a business manager should not be reprimanded for have higher costs than projected because sales exceeded expectations and raise variable costs. At the same time, flexible budgets allow companies to award successful departments with more income. If the research and development department is making a higher income, it can be awarded with more funds to conduct further research, creating a healthy chain reaction.
Moving Costs Down
In other areas, flexible budgeting allows manages to move costs down to accurately represent sales figures and other information. If the manager adopts a new practice to help become more efficient or save money in operations, then the budget should be altered to more accurately examine how costs relate to the activity itself, not the more efficient method of doing it. The actual budget will show much money is saved from the change in process, while the flexible budget can be changed during the activity to budget money more carefully.
Preparing for the Unknown
Many companies create flexible budgets with a series of possible variable costs. Instead of sticking with one sales figure, these budgets anticipate several sales scenarios based on current market activity. This way, the business is prepared to immediately implement a budget or switch from one type to another in response to activity levels. This helps the business anticipate changes and adapt more effectively.
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