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A budget is usually considered as a plan of the future activities. The budget is a planning tool that is divided into fixed and static budget. A flexible budget is a performance evaluation tool based on the level of activity while the static budget is a cost control tool that presents budgeted amount at the expected capacity. It is therefore, critical to differentiate the two types of budget and clearly distinguish them besides assessing the cost-volume-price analysis.
Flexible budget as a performance evaluation tool distinguishes between the fixed and variable costs as it allows for adjustment in the levels of activity attained through variation of variable cost. Flexible budget gives a measure of the level of production activity based on material acquisition, resource requirement and the labor needed. Grossman and Livingstone (2009) assert that the actual volume of activity differs with the expected level of activity. More significantly in the flexible budget the fixed costs do not vary with the volume whereas the variable cost fluctuates with the volume. As the variable cost varies the budget levels also fluctuates thus, it is necessary to acquire knowledge in identification of fixed or variable cost in order to develop the budget.
Static and flexible budgets
A static budget is a master budget, which is a plan based on outputs and inputs of each of the firm’s division. These are projected amounts that set the limits for the company. On the other hand, a flexible budget helps the company to plan for unexpected situations. Customers can see numbers and compare them to the planned activities through a flexible budget. In addition, a flexible budget can also provide data on how effective a company is planning, performing as it comprises of fixed cost and variable cost component. Flexible budget volume varies because the planned level is higher than the amount of volume produced thus, causing revenue to increase. Underpricing also contributes to fluctuations as it occurs when a company offers goods at a price below the market value as a result, company risks losing out on potential revenue. When comparing a static budget to a flexible budget, two types of variances are considered static budget variance and sales volume variance. The static budget variance arises from the difference between the results and the static budget and the sales volume variance is the difference between the flexible budget and the static budget (Investopedia, 2011). The flexible budget allows the company flexibility for adjustment in case of change in activities; therefore, the flexible budget would be a better choice to utilize.
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A cost-volume-profit (CVP) analysis is a system that observes variations in profits in retort to changes in sales volumes, costs, and prices. CVP analysis assist in planning the future levels of operating activity through assessing the products or services to emphasize, capacity of sales desirable to achieve a targeted level of profit, the amount of revenue required to avoid losses (Wiley, 2004). A CVP analysis can provide data on how much sales will be required to meet a company’s goals in revenue. CVP analysis acquires multiple levels of production data from the flexible budget that contributes to break-even mark sales and generates revenue. Another importance of CVP analysis is that it provides the total revenues in relationship to the total costs. This will provide data on the results if the fixed cost, sales price, or variable costs and how it increases or decreases and determine losses and profits for the company.
Indeed, it is clearly described that the budget is a clear plan that guides the organization decision making and planning. The existence of the static and flexible budgets allow for managers to make sound decisions. It is however, necessary to carry out a CVP analysis in order to ascertain the trend of the budget as it measures sales volumes, costs, and prices.