It also looked at the effect a change in price would have if the number of units remained the same. The expenses that do not change are the fixed expenses, as shown in Figure 10.25. 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.
Flexible Budgets and Sustainability
For example, finance can build a percentage into the basic flexible model, which they multiply by actual revenues to determine the expenses at a specified revenue level. It doesn’t provide the full level detail that a flexible budget would, but it does provide flexibility and a more accurate, up-to-date budget than a static budget. 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.
Optimal Usability in Variable Cost Environments
Which is why companies have moved away from traditional static budgeting to more flexible budgeting strategies. A flexible budget lets you adjust to global trends and economic changes rather than trying to anticipate when those will happen (and likewise brace for their impact). One of the biggest advantages of the consistency inherent in a static budget is the clean comparisons that it allows for. But a flexible budget introduces much more variance, which makes it difficult—if not outright impossible—for a team to perform an accurate revenue comparison or variance analysis based on an ideal or former scenario. 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. You can also study the monthly adjustments and notes to more accurately plan for future costs.
Compare your budget model with actual expenses with variance analysis
- 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).
- For example, organizations are often reporting their sustainability efforts and may have some products that require more electricity than other products.
- More than 3,000 active customers across the globe rely on Prophix to achieve organizational success.
- Be careful to set expectations with them that deviations from the budget come from the FP&A team.
We use our projected sales quantities and prices, materials, labour and overhead to generate our budgeted profit. The second budget is our flexible budget – using all of the same assumptions about sales price, cost of raw materials and cost of labour – but adjusted for the actual units sold. Big Bad Bikes is planning to use a flexible budget when they begin https://marylanddigest.com/navigating-financial-growth-leveraging-bookkeeping-and-accounting-services-for-startups/ 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.
Flexible budgets create an accurate picture of production costs
At its simplest, the flexible budget alters those expenses that vary directly with revenues. There is typically a percentage built into the model that is multiplied by actual revenues to arrive at what expenses should be at a stated revenue level. In the case of the cost of goods sold, a cost per unit may be used, rather than a percentage of sales. Within an organization, static budgets are often used by accountants and chief financial officers (CFOs)–providing them with financial control. The static budget serves as a mechanism to prevent overspending and match expenses–or outgoing payments–with incoming revenue from sales.
4 Flexible Budgets
A Flexible Budget is a budget or financial plan that varies according to the company’s needs. They made it flexible because the specific company’s or department’s needs do not remain static. 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. When using a static budget, a company or organization can track where the money is being spent, how much revenue is coming in, and help stay on track with its financial goals. As you can see, the flexible budget indicates we should have made $16,600 in profit, a more reasonable number than $42,500 given the decrease in sales by 7,000 units. 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.
- Once you have created your flexible budget, at the end of the accounting period you will want to compare the flexible budget totals against actuals.
- There were also fixed costs of $25,000 related to the factory and $25,000 related to selling and administration.
- A flexible budget is best used in a manufacturing environment where the budget is able to be based on production volume.
- A positive (or favorable) flexible budget variance number means you came in “above plan,” while a negative (or unfavorable) number means you weren’t as profitable or you spent more than you expected.
- As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration.
- This type of flexible budget takes into account how changes in activity levels affect all costs and provides the most accurate picture of expected costs at different levels of activity.
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 Navigating Financial Growth: Leveraging Bookkeeping and Accounting Services for Startups 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.
Understanding a Static Budget
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.
Some companies have 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. 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.
Let’s say a restaurant has a fixed budget of $10,000 for food expenses for the month, which is based on an expected number of customers served. However, the restaurant experiences a significant increase in customer traffic during a particular week, resulting in higher food costs. Budget variance analysis is an essential final step of any budgeting process and a necessary prerequisite to the next budgeting cycle. A flexible budget provides guidelines for a company to change their operations—to invest or divest in business practices—based on some external factor, typically revenue from those activities.
This way, budget adjustments can happen in real time while taking into account external factors like economic shifts and rising competition. 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. Flexible budgets are prepared at the end of each analysis period (usually monthly), rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level. Flexible budgets are prepared at each analysis period (usually monthly), rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level.