Budgets, aside from being a part of every person’s daily life, is also a crucial outline for many businesses. It serves as a guide for managers as well as a gauge of performance by the end of a period. Unlike individual allowances, proper allocation of a firm’s funds is more complex as it involves a lot more. Deciding how much you will take out is only the tip of the iceberg, you also need to make sure your expenses are well in accordance with how well the results of your operations are. This is considered a universal tool as well, since it is a necessity for households and even for multi-billion dollar corporations.

Normally, firms start with a static budget. This is comprised of figures based on proposed inputs and outputs for each department, and is the first part of drafting a blueprint of finances. It determines how much a company has and the amount it is willing to take out for a certain span of time. These are projected sums which will serve as a limit, which are generated from by using economic forecasting measures.

However, it is inevitable to encounter unforeseen expenses, so having a budget does not necessarily mean being confined to it even in emergency cases. Hence it may be changed, depending on the management’s decision.

Budget as a standard

By the end of a given period, this plan will be used to determine whether the business’ performance is in accordance with what they spent. This is where the flexible budget enters in which the numbers are based on the productivity and is compared with the static one to obtain the level of spending initially planned and what actually occurred. It has two components: the variable and fixed cost. The former varies depending on production output while the other does not change despite an increase or decrease in the amount of offerings sold.

Meanwhile, a static budgeting system has two basic variances. The first one is the flexible budget variance, which indicates the effect of costs on operations. The second, sales volume variance, signifies the impact of activities on operations and if this resulted to an unfavorable figure, it means a company’s sales will turn out to be less than expected. These measurements will let the managers know where their firm is struggling or advancing, guiding them in implementing the necessary alterations in their processes.