This year, we have spent time sharing a lot of business budget information. Why you need one, the importance of having a financial plan, and how procrastination and perfectionism can be roadblocks to financial success. Today, we want to dive into two different types of financial budgets and which is best for your business.
Types of Budgets
A static budget is the simplest to create. This model is used to evaluate sales income and expense management. Static budgets are created based on projections and do not change based on business activities. For example, if actual sales exceed planned sales, the static budget does not change. You can use your static budget to create variance reports comparing what you intended versus what happened.
Advantages of a Static Budget
This model can work wonderfully if your business has reasonably predictable revenue and expenses without much variation. A predictable business without much change makes budgeting more straightforward, and your static budget measures how well things are going compared to expectations.
Some other benefits of a static budget:
- It is the simplest way to get into budgeting for your business. The simple model is easy to use if you are new to budgeting.
- Easier to plan for the future. If you have steady revenue and expenses, knowing your budget is the same no matter what allows you to plan efficiently.
- Easier saving. When you have a fixed budget, you can create a recurring monthly savings deposit.
Disadvantages of a Static Budget
A static budget only works well for businesses without a lot of variance in operating expenses. For example, if you set a marketing budget and come in below your maximum spend, you might feel like you did well staying within budget, and if your marketing results help you meet your targets, then well done! On the other hand, what if you stay within budget, but your marketing results could be better? You stayed within budget (which is the measurement), but with more flexibility, you could pivot to different opportunities that may have delivered better results.
A similar problem can arise when sales are much higher than expected. With additional clients, you will need to spend more to fulfill obligations, leading to going over budget. Being over budget results in an unfavorable variance even though the additional spending resulted from better sales!
What is a Flexible Budget
A flexible budget is, just as it sounds, flexible. Flexible budgets are modified during the year for sales levels, changes in costs, and any other change in business operating conditions.
Advantages of a Flexible Budget
A flexible budget is more realistic and allows you to adjust based on what is happening in your business. As we learned during COVID-19, flexibility and the ability to pivot quickly was the difference between life and death for small businesses.
A flexible budget model can justify significant variances from the planned to actual numbers based on changes in operations like increased demand or external factors. The flexibility of this budget model makes even more sense for businesses that do not have consistent revenue or historical data to pull from.
Some other benefits of a flexible budget:
- Take advantage of opportunities. If sales increase dramatically, you can adjust to spending more on the things that will support the new clients, such as tools and staff.
- Make adjustments for costs and profit margins. If material costs go up during the year, a flexible budget will spot the variance allowing you to take corrective action. That might mean a price increase or discontinuation of the product.
- A more accurate picture of the business in the moment. Revenues and expenses are constantly adjusted in flexible budgets for the current operating conditions. Suppose something significant happens (downturn in the market, pandemic, etc.) You can update your projections and control costs.
Disadvantaged of a Flexible Budget
A flexible budget can be more challenging to track because there isn’t always a direct correlation between revenue and variable expenses. This means you might not see the 1:1 revenue results from your expenditures. If your costs aren’t directly related to revenue, this budget model will be trickier. Finally, a flexible budget is a lot more work to develop and maintain as you must update and evaluate frequently.
Which Types of Business Budgets Does Your Business Need?
Businesses can benefit from using both types of budgeting with some simple modifications.
Think of your static budget as your initial projection for the year ahead. This is the projection of your revenue and expenses that you know will occur based on what happened in the previous 12 months. If your business revenue is stable and predictable, you might get by with only a static budget.
A flexible budget makes sense if your business finances are more complicated or variable. You can set
your expenditure goals as percentages of revenue, allowing you to manage spending based on what is happening in your business.
A company may use both types of budgets for different reasons. A static budget can work well for short periods or for companies that work with predictable revenue and expenses. If you have a specific project or initiative with a fixed expenditure amount, a static budget works well! While a flexible budget is better for long-term planning, especially if revenue is not predictable.
At 4 Corners CFO we believe rigid budgeting is typically not very helpful. Things can change in your business and in the world. Being able to respond and adjust quickly is critical for long-term success. While a flexible budget is our preference, there is a place for a static budget if there is no variance in a project spend or a short-term project.
A Budget Should be Reviewed Often
No matter which type of budget you are using, remember that you need to revisit it often. Even a static budget needs to be monitored frequently. Your budget is the roadmap for the year ahead and you need to know when you’re getting off track. Make an appointment with yourself to review your budget quarterly at a minimum.
Whether you are rocking your annual budget or still need to make a 2023 financial budget, we are here to help! We can assist you in creating a clear financial plan for growth and profitability. Our CFO services are for businesses ready to take control of their revenue and have the most profitable year yet!