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A flexible budget starts with fixed expenses, then layers a flexible budgeting system on top that allows for any fluctuation in costs. Most flexible budgets use a percentage of projected https://kelleysbookkeeping.com/ revenue to account for variable costs. This way, budget adjustments can happen in real time while taking into account external factors like economic shifts and rising competition.

• Actual expenses are lower because the income before income taxes was lower.
• 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.
• At 50% capacity, the cost of working raw materials increases by 2% and the selling price falls by 2%.
• Big Bad Bikes is planning to use a flexible budget when they begin making trainers.
• That would mean the budget would fluctuate along with the company’s performance and real costs.

Then the budgeting staff completes the remainder of the budget, which flows through the formulas in the flexible budget and automatically alters expenditure levels. 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. This flexible budget is unchanged from the original (static budget) because it consists only of fixed costs which, by definition, do not change if the activity level changes. A flexible budget is kind of a hybrid approach to financial planning. It begins with a static framework built from the costs that are not anticipated to change throughout the year.

In contrast, a flexible budget might base its marketing expenses on a percentage of overall sales for the period. That would mean the budget would fluctuate along with the company’s performance https://quick-bookkeeping.net/ and real costs. For example, let’s say a company had a static budget for sales commissions whereby the company’s management allocated $50,000 to pay the sales staff a commission.

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Only then is it possible to issue financial statements that contain budget versus actual information, which delays the issuance of financial statements. 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.

For example, if your production of widgets is 100 per month, your variable admin costs may be $200 per month. However, if your production of widgets is 200 per month, your variable admin costs would increase to $400. A flexible budget is one that takes into account your actual production and revenue rather than what you originally projected.

• The Finmark Blog is here to educate founders on key financial metrics, startup best practices, and everything else to give you the confidence to drive your business forward.
• Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
• If such predictive planning is not possible, there will be a disparity between the static budget and actual results.

One problem with its formulation is that many costs are not fully variable, instead having a fixed cost component that must be calculated and included in the budget formula. Also, a great deal of time can be spent developing cost formulas, which is more time than the typical budgeting staff has available in the midst of the budget process. Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information.

A flexible budget, while much more time-intensive to create and maintain, offers an incredibly precise picture of your company’s performance. Due to the ability to make real-time adjustments, the results present great detail and accuracy at the end of the year. Once you identify fixed and variable costs, separate them on your budget sheet. It is unlike the static or traditional budget, which cannot be changed once created.

Best Practices of Flexible Budgeters

Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. For example, Figure 7.24 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes. For example, Figure 10.26 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes.

What is a flexible budget?

The master budget, and all the budgets included in the master budget, are examples of static budgets. Actual results are compared to the static budget numbers as one means to evaluate company performance. However, this comparison may be like comparing apples to oranges because variable costs should follow production, which should follow https://bookkeeping-reviews.com/ sales. Thus, if sales differ from what is budgeted, then comparing actual costs to budgeted costs may not provide a clear indicator of how well the company is meeting its targets. A flexible budget created each period allows for a comparison of apples to apples because it will calculate budgeted costs based on the actual sales activity.

Benefits of a Static Budget

A static budget is one that is prepared based on a single level of output for a given period. A company makes a budget for the smallest time period possible so that management can find and adjust problems to minimize their impact on the business. 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 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. To account for actual sales and expenses differing from budgeted sales and expenses, companies will often create flexible budgets to allow budgets to fluctuate with future demand.

Budget with Varying Levels of Production

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). For example, a widget company might start out the year with a static planning budget that assumes that the cost to produce 10 widgets is $100, and the company will produce 100 units per month. Each unit will bring in a net profit of $50, so the net profit per month will be 100 X 50, or $5,000. The flexible budget at first appears to be an excellent way to resolve many of the difficulties inherent in a static budget. However, there are also a number of serious issues with it, which we address below.

A flexible budget provides budgeted data for different levels of activity. Another way of thinking of a flexible budget is a number of static budgets. For example, a restaurant may serve 100, 150, or 300 customers an evening. If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served? Similar scenarios exist with merchandising and manufacturing companies. To effectively evaluate the restaurant’s performance in controlling costs, management must use a budget prepared for the actual level of activity.

For SaaS companies, flexible budgeting relates more to the cost of revenue — the actual costs for creating and delivering a product/service to customers. The cost of revenue involves hosting fees, service and cloud fees, and website development. And because flexible budgets expand and contract in real time, they allow businesses to exist as the organic, growing entities that they are. Fixed expenses such as rent, utilities, equipment costs, and salaries usually make up a significant portion of any business budget. While it’s possible that these costs will change slightly, most businesses simply budget for them upfront.