Flexible budget financial definition of flexible budget

Flexible Budget

It is important to be able to quickly adjust a budget as needed. A flexible budget is an operating budget that features alternative estimates for various line items.

An advanced flexible budget will also change based on the actual expenses for each category. This type of budget flexes with a company’s expenses that change directly in relation to its revenue. A basic budget may build in a percentage that varies based on revenue. This type of budget is typically used to denote cost per unit or percentage of sales. By using the flexible budget formula, a series of budgets can be easily developed for various levels of activity.

Run a Finance Blog? See How You Can Partner With Us

In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity. This type of budget is most often based on changes in a company’s actual revenue and uses percentages of revenue rather than static numbers. For example, a flexible budget may allot 25% of a company’s revenue to salary as opposed to allotting $100,000 to salary in a given year. This accounts for any changes in both the company’s revenue and staff that may occur throughout the year. The fixed budget is suitable for a department whose workload does not have a direct relationship to sales, production, or other volume related to a department’s operations. The workload is determined primarily by management decision instead of sales volume. Some examples of departments in this category are administrative and marketing.

Flexible Budget

Input the final flexible budget from an accounting period into your accounting software to compare it to the expenses you initially anticipated. Divide the budget you plan on spending on variable costs by your estimated production. Taking a flexible approach to budgeting typically doesn’t mean you get a free pass when it comes to moretraditional, staticbudgeting. In fact, the static budget is essential for establishing a baseline to measure performance and results and ultimately for calculating the variances that do occur throughout the year.

Categories of Expenses in a Flexible Budget

A flexible budget is a budget that is created using a specific cost or formula. Unlike a static budget, a flexible budget includes both fixed and variable costs that can be adjusted based on revenue percentage or production cost incurred throughout the course of the budget period. The flexible budget uses the same selling price and cost assumptions as the original budget. The variable amounts are recalculated using the actual level of activity, which in the case of the income statement is sales units. A flexible budget is a budget that adjusts to the activity or volume levels of a company. Unlike a static budget, which does not change from the amounts established when the budget was created, a flexible budget continuously “flexes” with a business’s variations in costs.

Flexible Budget

And if the factory operates for 3,500 machine hours in May. Flexible budgets can be very useful, but they do have some downsides. Let’s face it – business moves fast, and we have to be flexible for what is thrown at us. Customize Your Model Financial models based on templates aren’t very flexible.

The Flexible Budget as a Development Tool: Evidence From the Personal Preparation Course

And the estimates of expenses developed via a flexible budget helps in comparing the actual cost incurred for that level of activity. Hence any variance identified helps in better planning and controlling.

But now more than ever, it’s an essential tool for modern FP&A teams. However, if you updated the flexible budget for actual volumes and forecasted revenue was $1,250, then when compared to actual revenue of $1,500, volume is no longer an explanation for the variance. Instead, you will have to analyze the sales mix, pricing, etc. A static budget forecasts revenue and expenses over a specific period but remains unchanged even with changes in business activity. This flexible budget variance analysis will help you become more accurate year after year with respect to your budget.

Similar articles

The ability to provide flexible budgets can be critical in new or changing businesses where the accuracy of estimating sales or usage my not be strong. For example, organizations are often reporting their sustainability efforts and may have some products that require more electricity than other products. The reporting of the energy per unit of output has sometimes been in error and can mislead management into making changes that may or may not help the company. It helps the management to decide the level of output to be produced in order to generate profits for the business based on budgeted cost at different activity levels and budgeted sales. The flexible budget can be used for the determination of budgeted sales, costs, and profits at different activity levels. Plot the variable and fixed costs for the budgeted activity level and this will lead to the creation of a flexible budget.

Finmark is everything you need to build an accurate, customized financial model. No matter which type of budget model you choose, tracking your finances is what matters most. Creating a https://www.bookstime.com/ is a lot of work and requires a great deal of time to develop and maintain. Flexible budgets offer close monitoring of expenses versus revenue, and they allow for the opportunity to test things out and see what might work and what won’t without rigid financial constraints. Flexible budgets are dynamic systems which allow for expansion and contraction in real time. They take into account that a business is an organic, growing system and that life is not predictable.

How to create a flexible budget

So if the initial static budget called for 25% to be spent on marketing, the flexible budget will maintain that same percentage for marketing whether the budget increases or decreases. Revenue and cost needs to be compared monthly and adjustments or notes should be made. Additionally, flexible budgets have a lack of accountability to some degree since they are so fluid and open to change.

  • A flexible budget makes different amounts available to departments depending on what production or sales are realized.
  • Variable costs can include marketing and sales, and may also include the cost of materials, number of sales, and shipping costs.
  • The former editor of Consumer Reports, she is an expert in credit and debt, retirement planning, home ownership, employment issues, and insurance.
  • For example, if your business predicts that five units will sell per month at $5 each, you can expect a revenue of $25 a month.
  • This budget can be prepared even if the activity level is not decided since fixed costs are already known to every department and variable costs can be approved as a percentage of sales per unit.

Also, temporary staff or additional employees needed for overtime during busy times are best budgeted using a Flexible Budget versus a static one. The original budget assumed 17,000 Pickup Trucks would be sold at $15 each. To prepare the flexible budget, the units will change to 17,500 trucks, and the actual sales level and the selling price will remain the same. Given that the variance is unfavorable, management knows the trucks were sold at a price below the $15 budgeted selling price. A flexible budget is useful for manufacturing industries where costs change with a change in activity level. To make accurate budgets, companies must involve experts so that there is less scope for error and variance analysis is improved.

What is a Static Budget?

Determine what costs will be incurred at different levels of activity. Flexible budget variance techniques help you create budget forecasts that make sense in a time of disruption, making it easy to course correct when needed. A budget is an estimation of revenue and expenses over a specified future period of time and is usually compiled and re-evaluated on a periodic basis.

What are the three types of flexible budget variances?

Favorable variances arise when actual results exceed budgeted. Unfavorable variances arise when actual results fall below budgeted. Favorable profit variances arise when actual profits exceed budgeted profits. Unfavorable profit variance occurs when actual profit falls below budgeted profit.

Flexible budgets are one way companies deal with different levels of activity. A flexible budget provides budgeted data for different levels of activity.

This does not always happen but is why flexible budgets are important for giving management an indication of what questions need to be asked. Thereafter, prepare a flexible budget for single or multiple activity levels. Thus, if the actual expenses exceed $8,880 by $X in the month with an 80% activity level, it would mean that the company has not saved any money but has overspent $X more than the budgeted amount. A flexible budget is much more realistic than fixed budgets since it gives emphasis on cost behavior at different levels of activity. There are many companies like service industries where variable costs don’t have a major role to play and such companies do not require a flexible budget. Your flexible budget would then look at revenue, based on both units sold and sales price. Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes.

Flexible Budget

Analyze cost behavior trends, whether fixed, variable, or mixed. More than half of professional services firms can’t forecast project revenue beyond six months. Workday’s Mark David and Justin Joseph share insights into how organizations can get revenue forecasting right, even when business is anything but usual. Yet other expenses have considerable chance of varying to one degree or another. For instance, staffing projections may be dependent on an expected long-term contract being finalized, or economic stresses cause you to extend payment deadlines or loosen return policies. No matter what, flexibility serves you at the moment you need it—and pays dividends down the line. Static budgets are often used by non-profit, educational, and government organizations.

Flexible budget variance analysis is an effective tool for developing a segregated, after-the-fact budget

Though the flex budget is a good tool, it can be difficult to formulate and administer. One problem with its formulation is that many costs are not fully variable, instead having a fixed cost component that must be calculated and included in the budget formula. Also, a great deal of time can be spent developing cost formulas, which is more time than the typical budgeting staff has available in the midst of the budget process. This is because not all costs a company may incur are variable and must be input into the budget as a fixed cost. Calculating each category and determining the type of cost it requires can be difficult and take time. A flexible budget allows a company to see when changes to certain costs should be made. This type of budget takes into account the variation and ranges of expenses based on each category of a company’s budget.

This flexible budget is unchanged from the original because it consists only of fixed costs which, by definition, do not change if the activity level changes. Through flexible budgeting, managers can perform comparative analysis. The analysis may include actual and budgeted costs and comparisons between different costs.

Leave a Comment

Your email address will not be published. Required fields are marked *