194 Understanding the Numbers
Organizations that have trouble predicting accurately the volume of ac-
tivity they will experience during the budget period often find that a budget
prepared for only one level of activity is not very helpful in planning and con-
trolling their business activities. These organizations can operate better with a
budget prepared for several levels of activity covering a range of possible lev-
els of activity. This type of budget is called a f lexible budget.
Fixed Budgets
A fixed budget, or static budget, contains budget data for only one specific vol-
ume of activity. Because fixed budgets use only one volume of activity in de-
termining all budgeted data, the fact that some costs are fixed and some costs
are variable has no impact on the budgeted figures. The budget data used in
preparing the budget for the planning phase of the process are also used in
budget performance reports during the control phase of the budget process re-
gardless of whether the volume of activity is actually achieved.
The planning and control framework provided by a budgeting system is an
essential element of effective management. In many organizations, fixed bud-
gets are tools that offer managers the ability to plan and control operations and
to evaluate performance. If, however, the actual volume of activity achieved
by a firm is sufficiently different from the volume planned in the fixed budget,
the fixed budget may be a very poor measure on which to base the perfor-
mance of employees.
Flexible Budgets
A f lexible budget, also called a dynamic budget, is prepared for more than one
level of activity. For example, a firm may prepare budgets for 10,000, 11,000,
and 12,000 units produced. The purpose of preparing budgets for multiple ac-
tivity levels is to provide managers with information about a range of activity
in case the actual volume of activity differs from the expected level. For plan-
ning material acquisitions, labor needs, and other resource requirements, man-
agers continue to rely heavily on the budget based on the expected level of
activity, but the f lexible budget provides additional information useful in mod-
ifying plans if operating data indicate that some other level of activity will
occur. When performance reports are prepared, actual results are compared
with a budget based specifically on the level of activity actually achieved.
Actual activity may differ significantly from budgeted activity because of
an unexpected strike, cancellation of a large order, an unexpected new con-
tract, or other factors. In a business that frequently experiences variations in
its volume of activity, a f lexible budget may be more useful than a fixed bud-
get. Flexible budgets provide managers with more useful information for plan-
ning and a better basis for comparing performance when activity levels
f luctuate than is available from a fixed budget. Flexible budgets are discussed
in more detail in Chapter 7.