A flexible budget, while much more time-intensive to create and maintain, offers an incredibly precise picture of your company’s performance. Due to the ability to make real-time adjustments, the results present great detail and accuracy at the end of the year. Though the flex budget is a good tool, it can be difficult to formulate and administer.
A flexible budget is designed to change based on revenue or production levels. Unlike a static budget, which can be prepared in anticipation of performance, a flexible budget allows you to adjust the original master budget using actual sales and/or production volume. A great deal of time can be spent developing step costs, which is more time than the typical accounting staff has available, especially when in the midst of creating the more traditional static budget.
In order to create an accurate business budget, you’ll need to separate fixed costs from variable costs since a flexible budget is only concerned with variable expenses, such as production levels, materials and labor. 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. This approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels. Budget versus actual reports under a flexible budget tend to yield variances that are much more relevant than those generated under a static budget, since both the budgeted and actual expenses are based on the same activity measure. This means that the variances will likely be smaller than under a static budget, and will also be highly actionable.
Advantages of Flexible Budgeting
For example, consider a web store that downloads software to its customers; a certain amount of expenditure is required to maintain the store, and there is essentially no cost of goods sold, other than credit card fees. In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget. In a flexible budget, there is no comparison of budgeted to actual revenues, since the two numbers are the same.
Using a flexible budget will immediately alert you to any changes that are likely to impact your bottom line, allowing you to make changes proactively instead of reactively. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration. Imagine your product goes viral on social media and gains unexpected popularity overnight, now there is a demand for 20 units next month, which would cost $20 to make. Now, let’s assume that it costs one dollar to make each unit of product, so you budget $5 a month for this. 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. These points make the flexible budget an appealing model for the advanced budget user.
- In short, the flexible budget is a more useful tool when measuring a manager’s efficiency.
- Flexible budgets work by taking the pressure off to predict future happenings.
- We’ve previously covered the five different types of budget models that businesses can choose from.
- The model is designed to match actual expenses to expected expenses, not to compare revenue levels.
The model is designed to match actual expenses to expected expenses, not to compare revenue levels. There is no way to highlight whether actual revenues are above or below expectations. 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.
What Are Flexible Budgets? 4 Best Practices
Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. 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. Creating a flexible budget begins with assigning all static costs a fixed monthly value, and then determining the percentage of revenue to assign to your variable costs.
It’s also important to request accountability for all changes made to this budget in order to keep it working for you. 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. The flexible budget at first appears to be an excellent way to resolve many of the difficulties inherent in a static budget.
Revenue Comparison
If you manage a high-level production environment, creating a flexible budget can help mitigate the typical variances found on static budgets. Now let’s illustrate the flexible budget by using different levels of volume. If 5,000 machine hours were necessary for the month of January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the machine hours in February are 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). With a flexible budget, it’s easy to show that while costs for a month might have been much higher than budgeted, so were sales – justifying the increase.
Time Delay Issues
Flexible budgets do not fix variances, they help to better plan for the future. Revenue is still calculated at month end so costs cannot be retroactively adjusted. After each month (or set period) closes, you compare the projected revenue against the actual revenue and adjust the next month’s expenses accordingly. We’ve previously covered the five different types of budget models that businesses can choose from. The flexible budget offers the most customizable experience, allowing it to be easily adopted by many different businesses. While preparing any budget at all is always better than not having one, a static budget does not prepare you for revenue and expense changes in real time.
Consequently, the flex budget tends to include only a small number of step costs, as well as variable costs whose fixed cost components are not fully recognized. A flexible budget often uses a percentage of your projected revenue to account for variable costs rather than assigning a hard numerical value to everything. This allows for budget adjustments to occur in real-time, taking into account external factors. It begins with a static framework built from the costs that are not anticipated to change throughout the year. Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance.
This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue. A flexible budget is best used in a manufacturing environment where the budget is able to be based on production volume. An alternative is to run a high-level flex budget as a pilot test to see how useful the concept is, and then expand the model as necessary. Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed for future periods. Flexible budgets take time to maintain, with routine monthly reviews and edits.
