What Are the Differences Between Fixed, Flexible, & Zero Based Budgeting Processes?
Budgeting is one of the most important tasks any business faces, because the budget dictates what the company can afford to do and therefore dictates operations to a large degree. However, companies have choices about how they budget. Three options include fixed or static budgeting, flexible budgeting and zero-based budgeting. Each option has slightly different processes.
Other People Are Reading
-
Fixed Budgeting
-
In a fixed, or static, budget, the budget shows results for only one level of activity, such as production. Even if that activity level changes, the budget does not. For example, if you budgeted $5,000, the budget would remain the same, regardless of whether you produced 300, 400 or 500 units. The basic process for a fixed budget thus is very simple: First, identify a base activity level. Then figure out what cost components you have, identifying which are flexible and which are static. Next, multiply the flexible costs by the activity level and add the static costs. Leave the budget alone for the entire budget period regardless of the actual activity level.
Flexible Budgeting
-
Flexible budgeting is basically the opposite of fixed budgeting. With this method, your company looks at multiple activity levels and creates a series of static budgets so the budget you use accommodates what really happened. For example, you could create budgets that allot $1,000 for 300 units, $1,500 for 400 units and $2,000 for 500 units. Once you've done this using the basic fixed budget process, compare the actual expenses incurred to the budgeted amount for actual activity. For example, if you produced 300 units and spend $750 to do it, you'd look at the budget for the 300-unit production level. Because you'd allowed $1,000 in that budget, you would come out $250 under budget.
-
Zero-Based Budgeting
-
Fixed budgets are often incremental. This means that companies use the budget from the previous budget period as a foundation, justifying only the difference, or increments, between the old and new budget item costs. For example, if the old budget allowed $500 and the new one allowed $600, you would justify the $100 increase. This also applies to fixed budgets, as fixed budgets are just a series of static budgets. Zero-based budgeting, however, is a budgeting method in which you start from scratch every time. To create this type of budget, you figure out your income, as well as your fixed and flexible expenses. You then allocate a percentage of your income to each expense, focusing on the fixed expenses first. When you subtract the expenses from your income, the total should be zero. If it is not, it means you have to adjust your allocation. Every dollar has to be accounted for in this budget method, so if you have more income than expenses, you include savings or similar allocations as regular expenses or give a higher percent to the expenses already listed.
Considerations
-
Each budgeting method and its related process has advantages and disadvantages. For example, a fixed budget requires much less work, but is not as accurate as a flexible budget. Similarly, a zero-based budget helps prevent budget padding, as you must justify everything, but it requires a lot of data and thus usually has to roll over through more than one budget period. Thus, companies have to pick the budget method and processes that work best for their given situations.
-
