What is Flexible Budget? Variance, Formula and Example
The accuracy of the budget largely depends upon the efficient classification of the costs. If the factory has to use more machine hours one month, its budget should logically increase. Conversely, if it uses them for fewer hours, its budget should reflect that decline. Its production equipment operates, on average, between 3,500 and 6,500 hours per month. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration.
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. 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. 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. 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.
Optimal Usability in Variable Cost Environments
Typically, the machine hours are between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. Instead, the hope is that https://www.bookstime.com/ patterns will be observed making future cost planning easier and more accurate. In addition, a flexible budget can successfully justify increases in costs when compared to actual income.
A static budget based on planned outputs and inputs for each of a company’s divisions can help management track revenue, expenses, and cash flow needs. Thereafter, prepare a flexible budget for single or multiple activity levels. For Example, A company has prepared a flexible budget and expects an output of 500 units. The columns would continue below with fixed and variable expenses, allowing you to see how your net profit changes based on changes in actual production and revenue.
Doesn’t Apply to All Line Items
The main difference between a flexible budget and a static budget is that a flexible budget adjusts to changes in activity levels, while a static budget remains fixed regardless of changes in activity levels. A flexible budget is an adjustable budget that companies create for different levels of activity, i.e., different output levels, revenues, or expenses for a single budgeting period. Companies with variable costs require flexible budgets because this kind of budget allows them to course correct or account for that variation with minimal disruption to their operations. Flexible budgeting can be used to more easily update a budget for which revenue or other activity figures have not yet been finalized. Under this approach, managers give their approval for all fixed expenses, as well as variable expenses as a proportion of revenues or other activity measures.
- A company wants to prepare a budget based on a scheduled activity level of 70% of the production capacity, where the number of units designed is 7000.
- Flexible budgeting is an adaptable budgeting method that enables businesses to modify expense constraints in real-time according to changes in costs, production, sales, or other factors.
- Actual revenues or other activity measures are entered into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs.
- 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.
- A static budget based on planned outputs and inputs for each of a company’s divisions can help management track revenue, expenses, and cash flow needs.
This ability to change the budget also makes it easier to pinpoint who is responsible if a revenue or cost target is missed. A static budget is one that is prepared based on a single level of output for a given period. The master budget, and all the budgets included in the master budget, are examples of static budgets. Actual results are compared to the static budget numbers as one means to evaluate company performance. However, this comparison may be like comparing apples to oranges because variable costs should follow production, which should follow sales.
Basic Flexible Budget
Then, they can modify the flexible budget when they have their actual production volume and compare it to the flexible budget for the same production volume. A flexible budget is more complicated, requires a solid understanding of a company’s fixed and variable expenses, and allows for greater control over changes that occur throughout the year. For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier. In a static budget situation, this would result in large variances in many accounts due to the static budget being set based on sales that included the potential large client. A flexible budget on the other hand would allow management to adjust their expectations in the budget for both changes in costs and revenue that would occur from the loss of the potential client. The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance.
Forecasting tools can integrate with various data sources, like Xero Accounting, and spreadsheets, to collect accurate data on activity levels and costs. They enable scenario modeling to project different outcomes based on varying activity levels, ensuring adaptability in budgeting – something that is essential in flexible budgeting. These advantages collectively empower a business what is a flexible budget to respond swiftly to changes, optimize resource utilization, and make well-informed financial decisions. By accommodating changes in activity levels, flexible budgeting enhances financial management practices and supports more accurate forecasting and planning. Some companies have so few variable costs of any kind that there is little point in constructing a flexible budget.
Comments are closed.