Static Budget Vs. Flexible Budget
Static and flexible budgets are two separate yet interconnected parts of a solid business accounting regimen. Static budgets are a good way to keep production costs on track, and encourage the staff in charge of purchasing to make the greatest possible effort to obtain the required goods at the lowest possible price. A flexible budget can sometimes account for an entire company budget; however, it is best used as part of a larger overall budget in a subsection role, such as a variable expense account.
A static budget is generally used as a projection tool for estimating business expenses within a given period of time. Discrepancies resulting from the fluctuating cost of raw materials or initial budgeting errors appear on a static budget as static budget variance. When accounting for the end of a production cycle's actual expenses, the static budget variance needs to be combined with the actual initial static budget in order to achieve accurate financial reporting. For the sake of simplicity, it can help to think of a static budget as a projection budget.
Flexible budgets work well as a performance evaluation tool in conjunction with a static budget and are basically a comprehensive accounting of the static budget's cost variance. Flexible budget expenditures can be stymied by offering employee performance incentives directly relating to staying on the static budget. A basic rule of thumb about flexible budgets is that they are a business cycle analysis tool and cannot be compiled before the end of the business cycle itself. Analyzing the flexible budget at the end of the business cycle allows management to adjust the next business cycle's static budget forecasts to match the changing circumstances of operating costs. In the simplest terms, a flexible budget can be described as an end of period actual accounting of expenses on which to form a comparison with the original static budget.
Most businesses should be using both static and flexible budgets during the course of their business operations, with the only notable exception being during business cycles when the company manages to strictly adhere to the original static budget, in which case the actual statistics contained within the static and flexible budgets would be equal.
Businesses that do not properly track shifting expenses compared to the initial static budget can have difficulty accurately reporting their real earnings, which can lead to negative legal implications in the future. Companies also have a vested interest in providing accurate information to shareholders so they can accurately manage their portfolios and adjust their dividend expectations accordingly.