A budget is very crucial and a spending plan based on income and expenses. In other words, it’s just an estimate of how much money you’ll make and spend over a certain period of time, such as a month or year. There are three main types of budget that are used for different industries such as fixed, flexible budget, and master budget.
Meaning of Fixed Budget
A fixed budget can be helpful when budgeted output is calculated to be similar to the actual output. The comparison between actual performance and budgeted numbers can help measure performance. In such circumstances, a static budget can aid in better control of management.
However, fixed budgets are not appropriate when the production figures vary substantially from the budgeted numbers. The large variations in expenditure and income can impact the value of a fixed budget. Fixed or static budgets display the numbers for a particular activity level, and using the same projections for a different activity level is likely to produce negative results. Static budgets have various limitations because it creates a specific amount of activity. It is the main types of budget.
Definition of Fixed/Static Budget
According to L.C.W.A. London, a “Fixed budget is created to be a constant budget regardless of the amount of actual activity.” Fixed budgets can be used in static circumstances. Because of this, static budgets are only sometimes utilized. These budgets only function when there is a large gap between the budgeted production figures and those produced. This constrains the usage of budgets as a measure of control.
This budget’s result must reflect an accurate picture of the company’s performance. Therefore, it needs to be more beneficial to the management to make future decisions.
Meaning of Flexible Budget
A flexible budget combines various budgets at multiple production output levels. Flexible budgets consider various factors that could result in a change in production levels. It recognizes various expenses, such as fixed, semi-fixed, and variable costs. This makes the budget more realistic and closer to the real world.
Definition of Flexible Budget
As per C.I.M.A., the term “flexible budget” is “A budget that, through understanding the different behavior between variable and fixed costs concerning fluctuations in output, turnover, or other variables such as the number of employees can be designed to adapt by these fluctuations.”
To create an affordable budget, the company must study the effect of changes in conditions on its final output. These circumstances could be related to installing new equipment or changes in production guidelines. This types of budget is very crucial for flexible timing.
Flexible budgets are ideal for the following scenarios:
- If the company’s revenues are not forecastable. For instance, the business might project costs at different production levels, for example, 8000, 10000, or 12000 units.
- In cases where an element of importance determine the production rate, and the availability of that element to certainty.
- When the company is involved in the development of an innovative product, and sales estimates are difficult to predict.
Advantages of Flexible Budget
The following are the significant advantages of having the flexibility of a budget:
- A flexible budget can help to plan the future for any activity level because it’s possible to predict within the appropriate interval.
- Flexible budget is a good option for controlling purposes since it allows you to evaluate the managerial performance relative to the work performed.
- Flexible budgets can serve the goal of controlling costs.
- It also assists in determining costs at different levels of activity. This also helps in determining the price of quotations.
- It assists in determining the impact of different volumes of work on profit, revenue, and costs.
Disadvantages of Flexible Budget
Here are the most important restrictions of a flexible budget.
- It presumes that costs are linear and disregard other aspects like bulk discounts. However, costs aren’t linear in a real-world situation, so budgets cease to be helpful.
- Flexible budgets are based on ongoing activities and do not consider unpredictable expenses.
- Flexible budgets split expenses into fixed and variable elements randomly. So, budgeted numbers are separate from the actual cost.
- Flexible budgets maintain fixed expenses at the exact level across every activity level, but fixed costs can change once you cross the appropriate output range.
Meaning and Definition of Master Budget
The master budget provides an overview of the various “functional budgets.” It is created by consolidating multiple budgets. It also helps forecast the profit and loss accounts and the budgeted balance sheets. As per Rowland and William H. Harr, the master budget is “A summation of the budget in capsule form for the goal of presenting as one report the main points of the forecast for the budget.”
In the words of The Institute of Management Accountants, London, “The master budget, which includes its components functional budgets, is then accepted, adopted and implemented.”
The fund is used to coordinate and control various functional departments. The chief budgetary officer creates master budgets. This types of Budget is generally used for the long-term purpose. It must get the approval of the Budget Committee.
Advantages of Master Budget
A brief overview of all the operating budgets is provided within this budget.
- The master budget is a reference point for all available budgets.
- This types of budget assists in determining the validity of functional budgets by including summaries.
- It also gives estimations of profits for the budgeted time.
- Master budget contains details on the projected balance sheet.
- Set the goals for revenue, expenses, cashflows, profits, and expenses. It also serves as an instrument of control and assists in setting targets for organisational purposes.