Corporate Performance Management: Budgets

A budget is an estimate of income and expenses for a set period of time. They are operational and financial forecasting tools used to attempt to "predict" company-wide performance over a specified time frame. Budgets are an integral part of any successful business accounting regimen. Their intention is to create a plan of action for managers to coordinate the production, sales and/or service of the company’s performance, and then measure that plan against its actual performance. In other words, a budget is a tool that is used to help make business decisions.

There are 3 main types of budgets employed by most companies... 

1. The static budget is a budget that is based on projected levels of activity (planned outputs and inputs), developed prior to the start of the period. It's expressed as a set of budgeted financial statements for the selected time frame. The company uses it as an operating plan to carry out management’s plans to achieve company-wide goals and objectives. In summarizing management’s operating and financial plans for the upcoming period, it reflects the impact of the operating decisions and financing decisions to be made during the coming period. As the name "static" implies, it is the original budget for the period, not updated as information about the period becomes known.
2. While the static budget remains fixed and unchanged, the flexible budget uses figures that are based on actual output. This type of budget is prepared by adjusting the volume values (i.e. sales) in static budget to match the actual level of output derived at the end of the budget period. Since variances due to volume variations are expected, it does not make much sense to continue reporting them on the variance report as causes of variances. Flexible budgets help plan for potential changes in production costs or sales volume, and allow for businesses to respond quickly to changes and maximize profits by seizing the opportunity. Flexible budgets also provide for a greater degree of management control, for by eliminating sales volume as a source of variance, any variances highlight other causative factors.
3. A project budget is an entirely different type of budget than that of static and flexible budgets. While they are also used to forecast revenues and/or expenses, they do so for specific initiatives or projects, rather than operational activities. Examples of projects that might be budgeted for are: 1) capital budgeting projects - such as the purchase of a new machine or construction of a new plant, 2) the development and testing of a new product, 3) acquisition of another company, 4) a marketing plan for entering a new geographical area, 4) or a budget for a long-term contract. Projects must be planned over their entire life spans and should be viewed as special commitments. Their budgeted amounts must be integrated into the static budget of the company for the relevant period or periods.