What is a flexible budget? Definition and example
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. 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. The original budget for selling expenses included variable and fixed expenses.
Everything starts with the estimated sales, but what happens if the sales are more or less than expected? What adjustments does a company have to make in order to compare the actual what is a 12 month rolling forecast 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.
- Similar scenarios exist with merchandising and manufacturing companies.
- Semi-variable expenses remain constant between 45% and 65% capacity, increasing by 10% between 65% and 80% capacity, and by 20% between 80% and 100% capacity.
- The flexible budget cost of goods sold of $196,875 is $11.25 per pick up truck times the 17,500 trucks sold.
- If you do find yourself in the market for accounting software for your small business, be sure to check out The Ascent’s accounting software reviews and find an application that is a good fit for your business needs.
- If such predictive planning is not possible, there will be a disparity between the static budget and actual results.
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 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.
You should assume that the fixed expenses remain constant for all levels of production. 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. It may be favorable (higher than it should have been for actual production activity) or unfavorable (lower than it should have been). Although the budget report shows variances, it does not explain the reasons for the variance.
It helps to provide accurate forecasts without using theoretical data since they are based on what occurred. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Following are some of the advantages and problems of a flexible budget.
Categories of Expenses in a Flexible Budget
Both static and flexible budgets are designed to estimate future revenues and expenses. 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. A static budget helps to monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance. By keeping each department or division within budget, companies can remain on track with their long-term financial goals. A static budget serves as a guide or map for the overall direction of the company.
- In theory, a flexible budget is not difficult to develop since the variable costs change with production and the fixed costs remain the same.
- 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 based on planned outputs and inputs for each of a company’s divisions can help management track revenue, expenses, and cash flow needs.
- What adjustments does a company have to make in order to compare the actual numbers to budgeted numbers when evaluating results?
Then the budgeting staff completes the remainder of the budget, which flows through the formulas in the flexible budget and automatically alters expenditure levels. 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. 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.
Variance Analyses: Tale of Two Coffee Shops
Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. 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. In other words, comparing the $60,000 actual cost of making 125,000 units to the $50,000 budgeted cost of making just 100,000 units makes no sense. Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula. A factory is currently working at 50% capacity and produces 10,000 units.
Static budgeting is constrained by the ability of an organization to accurately forecast its needed expenses, how much to allocate to those costs and its operating revenue for the upcoming period. 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. For example, Figure 7.24 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes.
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. Steve made the elementary mistake of treating variable costs as fixed. After all, portions of overhead, such as indirect materials, appear to be variable costs. If Skate increased production from 100,000 units to 125,000 units, these variable costs should also increase. 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.
Creating a flexible budget
Companies develop a budget based on their expectations for their most likely level of sales and expenses. Often, a company can expect that their production and sales volume will vary from budget period to budget period. They can use their various expected levels of production to create a flexible budget that includes these different levels of production. 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.
This means that the variances will likely be smaller than under a static budget, and will also be highly actionable. In theory, a flexible budget is not difficult to develop since the variable costs change with production and the fixed costs remain the same. However, planning to meet an organization’s goals can be very difficult if there are not many variable costs, if the cash inflows are relatively fixed, and if the fixed costs are high.
Company
He has taught accounting at the college level for 17 years and runs the Accountinator website at , which gives practical accounting advice to entrepreneurs. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs.
What Are Flexible Budgets? 4 Best Practices
Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter. By the fourth quarter, sales are expected to be strong enough to pay back the financing from earlier in the year. The budget shown in Figure 7.25 illustrates the payment of interest and contains information helpful to management when determining which items should be produced if production capacity is limited. This is the simplest and most common budget for small businesses or for quick, high-level analysis. It typically adjusts the budgeted figures for one or a few key variables, such as sales volume or production levels.
So if the initial static budget called for 25% to be spent on marketing, the flexible budget will maintain that same percentage for marketing whether the budget increases or decreases. Accountants enter actual activity measures into the flexible budget at the end of the accounting period. It subsequently generates a budget that ties in specifically with the inputs. Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information.
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. If such predictive planning is not possible, there will be a disparity between the static budget and actual results. In contrast, a flexible budget might base its marketing expenses on a percentage of overall sales for the period.
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. The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250. Actual expenses are lower because the income before income taxes was lower.
