Flexible Budget Meaning Types, Formula, Examples

The ability to generate flexible budgets can be crucial in new or developing organizations when projecting revenue or use accuracy may be lacking. Organizations, for example, frequently report on their sustainability efforts and may have some items that demand more electricity than others. The reporting of energy per unit of output has occasionally been incorrect, which can lead to management making decisions that may or may not benefit the organization.

  • Flexible budgeting is a dynamic budgeting model that allows you to adjust to changes in costs and revenue in real time.
  • To determine the flexible budget amount, the two variable costs need to be updated.
  • Furthermore, as labor laws and minimum wage requirements change, the cost of labor rises.
  • The expenses that do not change are the fixed expenses, as shown in Figure 7.23.
  • When using a static budget, some managers use it as a target for expenses, costs, and revenue while others use a static budget to forecast the company’s numbers.

The variable costs and fixed costs are $7,000 and $10,000, respectively. Big Bad Bikes is planning to use a flexible budget when they begin making trainers. The company knows its variable costs per unit and knows it is introducing its new product to the marketplace. Its estimations of sales and sales price will likely change as the product takes hold and customers purchase it. Big Bad Bikes developed a flexible budget that shows the change in income and expenses as the number of units changes. It also looked at the effect a change in price would have if the number of units remained the same.

Revenue Comparison

However, if your production of widgets is 200 per month, your variable admin costs would increase to $400. Let’s assume a company determines that its cost of electricity and supplies will vary by approximately $10 for each machine hour (MH) used. It also knows that other costs are fixed costs of approximately $40,000 per month. Typically, the machine hours are between 4,000 and 7,000 hours per month.

  • The budget report is used by management to identify the sales or expenses whose amounts are not what were expected so management can find out why the variances occurred.
  • Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information.
  • In summary, it provides a mechanism for comparing actual to budgeted performance at various levels of activity.
  • Those siloes make flexible budgeting nearly impossible and limit the strategic value of an over-stretched finance team.

A flexible budget is a tool used in the preparation of financial statements. It allows companies to prepare budgets under different scenarios to be adjusted for future projections. Once you identify fixed and variable costs, separate them on your budget sheet. It is unlike the static or traditional budget, which cannot be changed once created.

These benefits make the flexible budget interesting to expert budget users. However, before making the switch to a flexible budget, consider the following considerations. At first, you need to analyze the range under which the activity is expected to fluctuate.

Mosaic automatically aggregates and consolidates all your financial data in real time, giving you a better starting point for the budget vs. actuals process so you can dig into the causes of budget variances more effectively. Better yet, when you have real-time budget visibility, you can forecast or update your budget (as needed) and see those updates reflected on other key metrics that matter to your business. Flexible budgeting puts more pressure on you to have rock-solid financial assumptions as you tie various line items together in the model. And the reality is that the effort you put into tying certain line items together may not be worth the time. Not every line item or set of line items has a strong enough correlation to others for flexible budgeting to work. Choosing the wrong pieces of the budget to tie together can lead to significant inaccuracies in forecasts.

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A static budget is a type of budget that incorporates anticipated values about inputs and outputs that are conceived before the period in question begins. A static budget–which is a forecast of revenue and expenses over a specific period–remains unchanged even with increases or decreases in sales and production volumes. However, when compared to the actual results that are received after the fact, the numbers from static budgets can be quite different from the actual results. Static budgets are used by accountants, finance professionals, and the management teams of companies looking to gauge the financial performance of a company over time. A flexible budget flexes the static budget for each anticipated level of production. This flexibility allows management to estimate what the budgeted numbers would look like at various levels of sales.

Static Budgets vs. Flexible Budgets

Thus, it provides a more accurate reflection of how costs and revenues change with fluctuations in activity. A fixed budget is one that does not alter according to changes in activity or output levels. A flexible budget is one that adjusts depending on the level of activity or unit production.

What are the advantages of flexible budgets?

Flexible budgets come with advantages like their usability in variable cost environments, their detailed picture of performance, and their overall efficiency for budgeting teams. But to really fall into strategic finance and budgeting, rather than asking if your budget should be flexible or static, incremental or strategic, you should focus on what line items you can forecast with a flexible method. More than likely, specific sections of your balance sheet or income statements could benefit from a bit more flexibility. The company also knows that the depreciation, supervision, and other fixed costs come to about $35,000 per month.

Flexible Budget Variance

The next three columns list different levels of output and the changes in variable costs based on the increased or decreased sales. 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. 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.

The variable amounts are recalculated using the actual level of activity, which in the case of the income statement is sales units. 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. It has been “flexed,” or adjusted, based on your real production levels. This approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels.

The result is that a flexible budget yields a budgeted cost of goods sold of $3.7 million at a $9 million revenue level, rather than the $4 million that would be listed in a static budget. Some companies have payments by wave 2020 so few variable costs of any kind that there is little point in constructing a flexible budget. Instead, they have a massive amount of fixed overhead that does not vary in response to any type of activity.

What adjustments does a company have to make in order to compare the actual numbers to budgeted numbers when evaluating results? If production is higher than planned and has been increased to meet the increased sales, expenses will be over budget. To account for actual sales and expenses differing from budgeted sales and expenses, companies will often create flexible budgets to allow budgets to fluctuate with future demand. A flexible budget starts with fixed expenses, then layers a flexible budgeting system on top that allows for any fluctuation in costs. Most flexible budgets use a percentage of projected revenue to account for variable costs. This way, budget adjustments can happen in real time while taking into account external factors like economic shifts and rising competition.

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