A flexible budget is one that takes into account your actual production and revenue rather than what you originally projected. This represents your best guess at what will be spent and what will be earned. Static budgets may be more effective for organizations that have highly predictable sales and costs, and for shorter-term periods. The flexible budget example below displays both the original static budget amount as well as a flexible budget based on increased production levels.
- A flexible budget might be used, for example, if additional raw materials are needed as production volumes increase due to seasonality in sales.
- A static budget serves as a guide or map for the overall direction of the company.
- To determine the flexible budget amount, the two variable costs need to be updated.
- Here, the figure indicates that the variable costs of producing 125,000 should total $162,500 (125,000 units x $1.30).
In short, a flexible budget requires extra time to construct, delays the issuance of financial statements, does not measure revenue variances, and may not be applicable under certain budget models. 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, top 4 use cases of automated bookkeeping in 2023 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. If so, one can integrate these other activity measures into the flexible budget model.
Compare the flexible budget to actual results
Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. The flexible budget will show different possibilities for variable expenses and revenue. Variable costs can include marketing and sales, and may also include the cost of materials, number of sales, and shipping costs.
Some textbooks show budget reports with “F” for favorable and “U” for unfavorable after the variances to further highlight the type of variance being reported. Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. Spending variance is the difference between what you should have spent at your actual production level and what you did spend. If it is favorable, you spent less than your actual production level should have required. Revenue variance is the difference between what revenue should have been for the actual production activity and what the actual revenue you take in is.
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Fixed expenses such as rent, utilities, equipment costs, and salaries usually make up a significant portion of any business budget. While it’s possible that these costs will change slightly, most businesses simply budget for them upfront. These variances are used to assess whether the differences were favorable (increased profits) or unfavorable (decreased profits). If an organization’s actual costs were below the static budget and revenue exceeded expectations, the resulting lift in profit would be a favorable result. Conversely, if revenue didn’t at least meet the targets set in the static budget, or if actual costs exceeded the pre-established limits, the result would lead to lower profits. While even a static budget is better than no budget at all, creating a flexible budget provides a much clearer picture of revenues and production costs.
Best Practices of Flexible Budgeters
If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). For costs that vary with volume or activity, the flexible budget will flex because the budget will include a variable rate per unit of activity instead of one fixed total amount. In short, the flexible budget is a more useful tool when measuring a manager’s efficiency. Your flexible budget would then look at revenue, based on both units sold and sales price. For example, your flexible budget may have three columns that show the number of units sold, the sales price, and total revenue.
By incorporating these changes into the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity. Over time, though, your actual production, sales, and revenue will change. These changes can be due to variations such as changing inventory costs, supply chain concerns, and market conditions. You would then take your static, or master, budget and adjust the numbers based on your actual revenue.
Thus, if sales differ from what is budgeted, then comparing actual costs to budgeted costs may not provide a clear indicator of how well the company is meeting its targets. A flexible budget created each period allows for a comparison of apples to apples because it will calculate budgeted costs based on the actual sales activity. A company makes a budget for the smallest time period possible so that management can find and adjust problems to minimize their impact on the business.
Accounting Principles II
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. Suddenly, there is only one company to meet demand for widgets, resulting in actual sales of 200 units per month.
If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served? Similar scenarios exist with merchandising and manufacturing companies. To effectively evaluate the restaurant’s performance in controlling costs, management must use a budget prepared for the actual level of activity. This does not mean management ignores differences in sales level, or customers eating in a restaurant, because those differences and the management actions that caused them need to be evaluated, too. Big Bad Bikes is planning to use a flexible budget when they begin making trainers.
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. In its simplest form, the flex budget uses percentages of revenue for certain expenses, rather than the usual fixed numbers. This allows for an infinite series of changes in budgeted expenses that are directly tied to actual revenue incurred. However, this approach ignores changes to other costs that do not change in accordance with small revenue variations. Consequently, a more sophisticated format will also incorporate changes to many additional expenses when certain larger revenue changes occur, thereby accounting for step costs.
In order to accurately predict the changes in costs, management has to identify the fixed costs and the variable costs. Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases. Instead of estimating production levels, use the actuals from the previous month to create your flexible budget. For instance, if your company produced 50,000 units in January, and you want to budget for 75,000 units in February, you have to look at your variable costs. While variances are noted in static budgets, a flexible budget allows you to enter the revenues and expenses relevant to that particular budget period, adapting flexible costs using real-time data. A flexible budget is a budget that is created using a specific cost or formula.
To compute the value of the flexible budget, multiply the variable cost per unit by the actual production volume. Here, the figure indicates that the variable costs of producing 125,000 should total $162,500 (125,000 units x $1.30). To compute variances that can help you understand why actual results differed from your expectations, creating a flexible budget is helpful. A flexible budget adjusts the master budget for your actual sales or production volume.
Once you identify fixed and variable costs, separate them on your budget sheet. For example, under a static budget, a company would set an anticipated expense, say $30,000 for a marketing campaign, for the duration of the period. It is then up to managers to adhere to that budget regardless of how the cost of generating that campaign actually tracks during the period. While accounting software is an important part of tracking all of your financial transactions, many software applications simply don’t have the capability of preparing a flexible budget. Keep in mind that if you or your bookkeeper are unfamiliar with cost accounting, the process of creating a flexible budget is best left in the hands of an accounting professional or CPA.