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A fixed budget, sometimes called a static budget, contains budget data for only one specific volume of
activity. Because fixed budgets use only one volume of activity in determining 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 regardless 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 budgets 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 of activity planned in the fixed budget, the
fixed budget may be a very poor measure on which to base the performance measurement of
employees.
Flexible Budgets
A flexible 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 of production. The purpose
of preparing budgets for multiple activity levels is to provide managers with information about a range
of activity in case the actual volume of activity differs from the expected level. Managers continue to
rely heavily on the budget based on the expected level of activity for planning material acquisitions,
labor needs, and other resource requirements, but the flexible budget provides additional information
useful in modifying 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 contract, or other factors. In a business that
frequently experiences variations in its volume of activity, a flexible budget may be more useful than a
fixed budget. Flexible budgets provide managers with more useful information for planning and a
better basis for comparing performance when activity levels fluctuate than is available from a fixed
budget.
The Profit Plan
The term profit plan is sometimes used to refer to a master budget. Profit plan probably best describes
the operating part of the master budget of a profit-oriented firm. However, it can be argued that the
entire master budget of profit-oriented firms is the total profit plan for the firm. The operating budget
shows details of budgeted net income, but the financial budgets, such as cash and capital expenditure
budgets, are also an integral part of the overall profit planning of the firm.