A flexible budget cannot be downloaded into accounting software to be compared to financial figures. Only then can financial statements with budget versus actual information be issued, which delays the issuance of financial statements. It is the calculated difference between the planned or forecast budget against the actual results.

As the production level is set as an activity level to determine the budgetary and actual results, the variance in margins can be analyzed based on production levels. A production level of 100% efficiency remains unachievable for any business. The flexible budgeting can forecast the difference in margins if all other things being equal, the variance in margins will change with production levels. Imagine a retail store that creates a flexible budget for its monthly operating expenses. The store’s fixed costs, such as rent and salaries, remain constant at £10,000. Additionally, variable costs, like inventory and utilities, are projected at £5,000 for an assumed activity level of 1,000 customers.

• This adaptability makes them valuable for dynamic environments, enabling better performance evaluation and resource allocation.
• The table below shows the calculations for units produced at 70% capacity and calculates the variable cost per unit for all variable costs.
• A flexible budget is one that adjusts depending on the level of activity or unit production.
• Flexible budgets take into account any activity level; therefore the activity level can be different for any business.

Company

This is because the fixed expenses don’t change irrespective of the activity level and the semi-variable expenses do change but not in proportion to the activity level. Only the purely variable expenses vary proportionately with the activity level. Establish how variable costs change in relation to revenue, production, or another key metric. Only within specified ranges of revenue or other activities may expenditures vary; outside of those areas, a different proportion of expenditures may apply. If the measures on which these expenditures are based exceed their target ranges, a smart flexible budget will adjust the proportions for these expenses. By following best practices and avoiding these pitfalls, businesses can fully leverage the benefits of flexible budgeting.

Financial forecasting software is well-suited for managing flexible budgeting. 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 modelling to project different outcomes based on varying activity levels, ensuring adaptability in budgeting – something that is essential in flexible budgeting. A flexible budget model, for example, is created with the expectation that the price per unit will be $100. In the most recent month, 800 units were sold at a cost of $102 per unit.

For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

Flexible budgeting can be used to more readily adjust a budget that has not yet been finalized in terms of revenue or other activity figures. Managers offer their permission for all fixed expenses, as well as variable expenses as a percentage of revenues or other activity measurements, under this strategy. The remainder of the budget is then completed by the budgeting staff, which flows through the formulas in the flexible budget and automatically modifies expenditure amounts. Flexible budgeting provides useful information in advance that can help in better planning.

In its simplest form, the flex budget uses percentages of revenue for certain expenses, rather than the usual fixed numbers. 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 small revenue variations.

The Benefits of Flexible Budgeting

This budget is divided into variable cost and fixed cost components, with the variable costs being tied to the number of unit sales of the helmet. The resulting budget is shown in the following table, which notes both budgeted and actual results for the first month of the budget period. A flexible budget adjusts based on changes in actual revenue or other activities. The result is a budget that is fairly closely aligned with actual results.

• A production level of 100% efficiency remains unachievable for any business.
• We can calculate the flexible budget for any level of activity using these figures.
• The actual results are then compared with the forecast or planned budgets to analyze the variance.
• Early in the chapter, you learned that a budget should be adjusted for changes in assumptions or variations in the level of operations.
• Managers use a technique known as flexible budgeting to deal with budgetary adjustments.

A flexible budget is not difficult to create in theory because variable expenses change with production but fixed costs remain constant. However, meeting an organization’s goals can be challenging if there are few variable costs, cash inflows are largely fixed, and fixed costs are considerable. For example, according to this article, certain large U.S. cities confront challenging budgeting due to significant fixed costs.

Companies will frequently design flexible budgets to allow budgets to adjust with future demand in order to account for real sales and expenses diverging from anticipated sales and expenses. Across the landscape of financial planning and management, businesses often encounter fluctuations in their financial and operations variables. A key tool can come into play to help navigate these uncertainties and make better informed decisions – the flexible budget.

#2. Incorrect Sales and Cost Estimation

Static budgets usually consider fixed costs, set targets to achieve results within the allocated resources. flexible budget accounting The management may decide to change the production levels, depending on sales targets and other factors. The static budgets may then act as a starting point for a flexible budgeting approach. The revised budgets can then be compared with actual results to analyze realistic variance factors. The flexible budget approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels.

#2. Performance Evaluation

In Chapter 9, Using budgets to evaluate performance, we discussed the idea of a flexible budget – the restating of our original budget, but using the sales quantities that were actually recorded. The first is the static budget – our original budget – labelled static because it does not move or change. 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.

In the case of the cost of products sold, a cost per unit rather than a percentage of sales may be employed. Although the flexible budgeting approach offers greater advantages over static budgets, it also has some limitations attached. A Flexible budgeting performance report is the one that analyzes the actual results against the standard budgets.

Disadvantages of flexible budgeting

A positive variance means the company produced favorable results and achieved higher efficiency than planned. An adverse variance means the company failed to achieve the target or standard plans. As the budget can be made for any activity, the variance should also be analyzed separately for these activities. The variance analyses can help the management to understand the causes and cost drivers behind the change, positive or negative. It’s important to note that while flexible budgeting has its disadvantages, these challenges can often be managed with proper planning, accurate data collection, and skilled financial management. The choice between the two depends on business requirements for accuracy and adaptability versus the desire for a simpler budgeting process.

Types

Each type provides different levels of control and precision, allowing businesses to choose the right approach for their needs. Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. We have noticed that the recovery rate (Budgeted hrs/Total expenses) at the activity level of 70 % is $0.61 per hr. If the factory works hrs in a particular month, the allowances @ $0.61 will come put to be $9,760, which is not correct. As shown in the above table, the accurate allowance is computed to be $8,880.

Since the flexible budget restructures itself based on activity levels, it is a good tool for evaluating the performance of managers – the budget should closely align to expectations at any number of activity levels. It is also a useful planning tool for managers, who can use it to model the likely financial results at a variety of different activity levels. Let’s assume a company determines that its cost of electricity and supplies will vary by approximately $10 for each machine hour (MH) used.