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. Consequently, a more sophisticated format will also incorporate changes to many additional expenses when certain larger revenue changes occur, thereby accounting for step costs.
- A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses.
- Imagine a retail store that creates a flexible budget for its monthly operating expenses.
- Simply put, it is how a business calculates its budget, estimates its needs, and how many goals the business wants to achieve.
- Implementing financial management strategies can further enhance the adaptability of your budget.
- Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula.
What is a Flexible Budget and How to Create it?
The definition of a fixed budget is a budget that is set on the basis of fixed production or sales. Of course, these two types of budgets aim to help business leaders manage business finances properly and correctly. A flexible budget is a budget design method that can adjust or adapt to changes in the level or volume of activities. Flexible budgets are better suited to types of activity with variable volumes than static budgets. Consider the resources needed to maintain a flexible budget against the potential advantages.
The actual results are then compared with the forecast or planned budgets to analyze the variance. The activity level here may refer to different cost drivers affecting the variable costs such as labor hours, direct materials, or sales commission, etc. However they understands that significant increase in units sold renders the comparison of actual results and the static budget unfair. You are required to prepare a flexible budget at actual level of output and calculate flexible budget variances. A flexible budget adjusts based on changes in actual revenue or other activities.
The revised budgets can then be compared with actual results to analyze realistic variance factors. Flexible budget may also be useful in planning stage at the beginning of the accounting period. Flexible budgets are created with the aim that company financial managers can refer with a high degree of accuracy between actual results and the budgeted budget. This is why flexible budgets can be adjusted to the level of activity or production volume. This is intended to make it easier for cost owners to determine the budget when analyzing variable costs.
Variable costs
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. At its core, a flexible budget is a powerful financial planning tool that accommodates variations in activity levels or sales volumes. Unlike a static budget, which remains unchanged regardless of real-world changes, a flexible budget adjusts and aligns with the actual levels of activity. This adaptability allows businesses to make more accurate performance evaluations and forecasts, fostering better decision-making processes.
What is a Flexible Budget? Definition, Purpose, Function, Types, and Examples
Although the flexible budgeting approach offers greater advantages over static budgets, it also has some limitations attached. It is pertinent to note that actual results will always differ with the planned targets. Budgeting helps management to analyze the causes or factors behind the variances. Flexible budgets will allow the management to revise and adjust to the new targets. In our example, the company might have set a target of 90% production, revised it to 85% and still would have achieved a 75% production level. 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.
Collect actual results data
For example, a company may budget for electricity and supplies costs for operating a machine based on the number of hours it’s in operations. Since the company’s revenues have gone up to $110 million, the company will have a $55 million cost of goods sold as it’s 50% of the sales. In other words, some costs may fluctuate based on sales volume or other factors but other costs are not variable. The main disadvantage of a flexible budget is that not all costs are variable. Although there are important benefits to using flexible budgets, you should also be mindful of its drawbacks.
While a static budget does not change to reflect increased sales, a flexible budget does. As a result, businesses can better know where they can improve their marketing or other efforts as revenue grows. Flexible budgets can also be used to calculate different financial activities of a business, such as how much to spend on various expenses incurred during a certain period. The amount of these royalties will inevitably vary depending on the magnitude of changes in the company’s income, including changes in the company’s own operations.
This type allows companies to have a more realistic idea of the budget based on the evolution of costs and profit margins. This form is a budget prepared in a form that clearly describes only the variable and fixed elements of each cost element. Join over 25,000 businesses that trust Ramp to streamline their finance operations and improve resource allocation. If the factory has to use more machine hours one month, its budget should logically increase.
If you refer to the explanation from the Financial Services Authority (OJK), the definition of a flexible budget is a budget that can accept changes in calculations and costs. This budget can show how various types of expenses can differ for different production and sales volumes (flexible budget) . At Ramp, we understand the importance of adaptability in today’s fast-paced business environment. When sales fluctuate or unexpected expenses arise, a flexible budget adjusts accordingly. This keeps your financial plan relevant and accurate, no matter what changes occur.
For example, if the company sees that it can sell off more of its products by expending more on advertising costs, a flexible budget would help execute that. That’s why a flexible budget is very effective for companies who go through many changes during a particular period. Now let’s illustrate the flexible budget by using different levels of volume.
Corporate budgeting is a planned and controlled process for the purpose of estimating a company’s finances. Typically, flexible budgets are determined as a percentage of different company performance measures. The company’s fixed costs represent $25 million, which is 25% of its total revenues. In this context, if variable changes have not been recognized but there has been a significant increase or decrease in sales volume or costs, the company will not have accounted for that.
Thus, for a number of different situations, managers will have calculated their costs and revenues. If an unexpected event does occur, changing the level of activity, the management will be better prepared. A company may use flexible budgets to account for the variable costs in the operation of a plant or equipment. Now, if the company’s revenues were to go up by 10%, using a flexible budget, the company will budget for an increase of $5 million in its variable costs.
- For a 10% increase in the company’s revenues, the company must plan an additional $5 million budget for to cost of goods sold.
- Flexible budget variances are simply the differences between line items on actual financial statements with those on flexed budgets.
- While the basic flexible budget is prepared, indicating how the expenses are completely in sync with the revenues generated, the intermediate type reflects the expenses beyond what is generated as revenue.
- By aligning with strategic goals, financial forecasting software like Brixx enhances the flexibility and precision of budgeting, contributing to better decision-making.
- Revenue is constantly changing and is the most important factor in business decisions, but the intermediate flexible budget includes costs that vary based on other activity measures.
Enter the final flexible budget for the accounting period into your accounting software to compare with your originally planned costs. This type of budget takes into account variations and ranges of costs based on each company budget category. This advanced budget will also change based on actual spending for each category. The definition of a flexible budget is a budget that can adapt to changes in production numbers and activities within the company. These budgets are more modern and useful than static budgets that cannot be changed once approved. A shoe making unit prepared a budget based on the expected sales volume and average output of the manufacturer.
The budgeted or planned sales volume of 255,000 units would yield profits of $667,250. If the company performs below targets and produces only 225,000 units its profits will fall showing an ADVERSE variance of – $ 178,500. Similarly, an above target performance will result in a FAVORABLE variance flexible budget definition of $ 89,250.