What Is A Flexible Budget?

If an unexpected event does occur, changing the level of activity, the management will be better prepared. Graphically, X-axis represents the level of activity, and Y-axis represents the estimated cost. The chart reads out the budgeted expenses at different levels of activity and helps in performance management. Therefore, we can conclude that with the change in the machine hours of the factory, the flexible budgets also change. Input the final flexible budget from an accounting period into your accounting software to compare it petfoodalpha to the expenses you initially anticipated. Because a flexible budget adjusts regularly to reflect a company’s current revenue, this type of budget cannot be used to compare actual expenses or revenue to expected expenses or revenue. This can make it difficult to determine if a company’s revenue is above or below what was expected.

Let’s say Green Company estimates their total production capacity to be 250,000 units. The direct material and labor costs per unit are $4.50 and $2.50 respectively. The company offers sales incentives to their sales force of 5% of sales. Enter actual activity measures into the model after an accounting period has been completed. In this method, the budget takes a tablet form, where horizontal columns represent the different levels of activity or capacity. And, the vertical rows represent the budgeted estimates against the different levels of activity or output.

1 Flexible Budgets

Now, between 85% and 95% of activity level, its semi-variable expenses increase by 10%, and above 95% of activity level, they grow by 20%. Prepare a flexible budget for the three scenarios wherein the activity levels are 80%, 90%, and 100%. No, a Flexible Budget is actually a very useful management tool which brings a new level of clarity to budget-to-actual analysis. In essence, it allows a transparent look at budget-to-actual results for variable costs — generally “direct” costs — by eliminating the sales variance component.

Product Reviews Unbiased, expert reviews on the best software and banking products for your business. Alternatives Looking for a different set of features or lower price point? Check out these alternative options for popular software solutions. As companies get larger, with more sophisticated finance operations, more data and more people involved, expectations should be higher.

How Do I Draft A Personal Budget & Savings Plan?

While even a static budget is better than no budget at all, creating a flexible budget provides a much clearer picture of revenues and production costs. Both static and flexible budgets are designed to estimate future revenues and expenses. A flexible budget can be a useful resource for business owners struggling to properly budget around variable costs.

Note that differing output measures do not present a problem for the flexible budget approach. This is because the production output is used only to calculate the flexible budget value that in our example is expressed as gallons of water regardless of how units of production are measured. Notice that although water efficiency improves in example 4, overall water intensity increases. This is due to the fact the production mix shifts from the less water intensive product Y to the higher water intensive product X.

A company Tech Blue co. estimates a total production capacity of 300,000 units. Direct material costs and labor costs per unit are $ 5.50 and $ 3.50 respectively. Additionally, the company offers sales incentives to the sales force on 5% of sales. What will be total cost of the unit production with a maximum utilized capacity of 85%? And if the company achieves lower efficiency of 75% production or higher 90% production capacity. This budget can be prepared even if the activity level is not decided since fixed costs are already known to every department and variable costs can be approved as a percentage of sales per unit. A flexible budget is made with the objective of reference with the actual results for the calculation of variances between the actual and budgeted results.

This makes a flexible budget a powerful performance evaluation tool. For accuracy, the variable cost should be used as a per unit or per activity level. Then, you compare the actual results with the forecast or plan budgets to analyze the variance. The activity level in the equation may refer to various cost drivers affecting the variable costs such as direct materials, labor hours, or sales commission. Variances can be calculated based on the revised budget and the actual performance. For example, consider a manufacturing company that predicts its revenue for January will be $100,000.

Flexible Budget Variance

Dummies has always stood for taking on complex concepts and making them easy to understand. Dummies helps everyone be more knowledgeable and confident in applying what they know. It helps in recognition of the operational inefficiencies and error. Let us consider firm M wants to determine the cost of electricity and supplies cost for its factory.

Flexible budget is budget typically in the form of an income statement that is adjustable to any level of activity such as units produced or units sold. In a simple flexible budget, fixed costs stay constant whereas variable and semi-variable costs change according to a standard predetermined at the beginning of an accounting period. Variable costs may be represented as percentages of some base figure such as number of units or revenue.

Positive And Negative Flexible Budget Variance

The budget is then compared to actual expenses for control purposes. The actual results are then compared with the forecast or planned budgets to analyze the variance.

For instance, the company might create a flexible budget reflecting its performance over the past five years, or since its creation. This shows stakeholders how well the company has performed overall. Adding all the static budgets together would show how much the company had expected to earn, showing stakeholders whether the company has met its own standards. Static budgets may be more effective for organizations that have highly predictable sales and costs, and for shorter-term periods.

Flexible Budget

A company can prepare an array of flexible budgets that each reflect a different scenario. Unlike a static budget, a flexible budget changes or fluctuates with changes in sales and production volumes.

• A flexible budget model takes variable expenses into account and demonstrates differing levels of revenue and expenses based on activity levels.
• Flexible budget is budget typically in the form of an income statement that is adjustable to any level of activity such as units produced or units sold.
• The management might assign a 7% commission for the total sales volume generated.
• “From there, you can drill down and get to multiple layers of complexity,” he said.
• Only the purely variable expenses vary proportionately with the activity level.
• «We have much better modeling programs than we’ve had in the past,» thanks to advances in computer model availability, McGuire says.

Management may set flexible targets to cover fixed costs and then gradually build on profits later. Variable costs assigned to sales activity or in percentage terms provide greater flexibility in profit analysis. Typically, static budgets considered a fixed cost and set targets to achieve those results within the available resources. Management may decide to increase or decrease production levels depending on sales targets and a variety of other factors.

Types Of Flexible Budget

It has columns for the actual and budgeted amounts and the differences, or variances, between these amounts. On an income statement budget report, think of how the variance affects net income, and you will know if it is a favorable or unfavorable variance. If the actual results cause net income to be higher than budgeted net income , the variance is favorable. If actual net income is lower than planned (lower revenues than planned and/or higher costs than planned), the variance is unfavorable. So higher revenues cause a favorable variance, while higher costs and expenses cause an unfavorable variance.

If you haven’t used a detailed budget before, it can seem a bit intimidating at first. Most of us need a few months of using our budget to make adjustments and improve accuracy and usefulness. Keep in mind that it’s a long-term change, not a one-and-done silver bullet for anything. Like eating better or paying more attention to your kids, have a little grace for yourself, but also realize that the cumulative effect is usually more important than any one moment or event. Then again, given today’s technology, you can create a budget online yourself and envision various scenarios almost as easily. Instead of sitting down every month and trying to sort through piles of receipts and remember where everything went, a few clicks or swipes as you go can categorize and analyze everything for you.

What Are The Steps To Developing A Flexible Budget?

It has extensive reporting functions, multi-user plans and an intuitive interface. flexible budget example Get clear, concise answers to common business and software questions.

He is the sole author of all the materials on AccountingCoach.com. Let’s suppose the production machinery had to operate for 4,500 hours during February.

These minor adjustments can help the company to achieve more efficiency. A static budgeting approach would compare the results at the end of the production period as variances cannot be adjusted. Total Mfg Overhead$92,500$95,000$97,250$100,000A flexible budget can be prepared for any level of activity. The advantage to a flexible budget is we can create a budget based on the ACTUAL level of production to give us a clearer picture of our results by comparing the flexible budget to actual results.

Our advocacy partners are state CPA societies and other professional organizations, as we inform and educate federal, state and local policymakers regarding key issues. Julia Kagan has written about personal finance for more than 25 years and for Investopedia since 2014. The former editor of Consumer Reports, she is an expert in credit and debt, retirement planning, home ownership, employment issues, and insurance. She is a graduate of Bryn Mawr College (A.B., history) and has an MFA in creative nonfiction from Bennington College. Our priority at The Blueprint is helping businesses find the best solutions to improve their bottom lines and make owners smarter, happier, and richer. That’s why our editorial opinions and reviews are ours alone and aren’t inspired, endorsed, or sponsored by an advertiser.

The expenses categorized into fixed, variable, and semi-variable costs. Flexible budgets calculate, for example, different levels of expenditure for variable costs. Subsequently, the budget varies, depending on activity levels that the company experiences. Once an accounting period is over, update your budget with the actual revenue and/or activity measurements.

Financial professionals are familiar with the fact that real-world results almost never align perfectly with the budget, even when careful steps are taken to account for variables. A flexible budget can be adjusted for real-world results, which allows businesses to analyze variances to and uncover insights about operations and costs. Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information. When preparing budget reports, it is important to include in the report the items the manager can control. If a manager is only responsible for a department’s costs, to include all the manufacturing costs or net income for the company would not result in a fair evaluation of the manager’s performance. If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance.

In this case, you create a personal budget based on your finances, income, needs and expenses. Then you adjust it based on how your spending shifts over the course of the year. It’s generally best to manage your budget on a monthly basis because this is how most billing cycles work.

Author: Ken Berry