A Small Business Guide to Flexible Budgets

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. It also looked at the effect a change in price would have if the number of units remained the same.

The company can then input their fixed costs, such as production materials, and determine their variable costs, which may include deliveries and other activities that are influenced by their sales. Using this budget allows the company to ensure more accuracy when determining how many sales they expect to make. Enter actual activity measures into the model after an accounting period has been completed. The focus of this article is to consider the impact of factory utilization on efficiency measurement. To be clear at the start, companies are constantly seeking to improve factory utilization most often by increasing production volumes. All other things being the same, increased production improves average intensity, but will not in itself create an efficiency improvement for environmental aspects. The flexible budget illustration for Mooster’s Dairy was prepared after actual production was known.

Flexible budgets create an accurate picture of production costs

A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses. In order to accurately predict the changes in costs, management has to identify thefixed costsand thevariable costs. Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases.

Revenue is still calculated at month end so costs cannot be retroactively adjusted. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound. We’ve previously covered the five different types of budget models that businesses can choose from. The flexible budget offers the most customizable experience, allowing it to be easily adopted by many different businesses. An alternative is to run a high-level flex budget as a pilot test to see how useful the concept is, and then expand the model as necessary. Note that fixed expenses and variable cost ratios didn’t change, because they don’t vary based on activity. However, variable expenses shifted considerably based on the number of customers, warranting the extra monitoring and maintenance.

What is a flexible budget?

Variable costs$7,000Fixed costs$10,000Prepare a flexible budget for capacity level of 80% and 90%. A company can also use the flexible budget in order to allocate funds for a particular project. For example, a company may decide to use 10% of its revenue for marketing purposes. The company can then Flexible Budget: What is it? create a flexible budget to allocate 10% of its earned revenue instead of a specific fixed amount. The revenue in a flexible budget cannot be compared to the actual revenue made by the company. Flexible budgets are usually produced monthly or quarterly, rather than in advance like static budgets.

These include the basic flexible budget, intermediate flexible budget, and the advanced flexible budget. Businesses can opt to use one of these based on the need or goals of the company. A flexible budget will show the variance in both revenue and spending. If your expenses aren’t directly related to revenue, this budget model probably won’t work for you. A flexible budget gives you wiggle room for the unexpected and unknown. This budget model can justify large variances which may have occurred because of increased demand or other external factors.

Performance Measurement

Companies that are static and execute the same transactions can significantly benefit from a fixed budget. But wherever there are fluctuations, a fixed budget doesn’t turn out to be the most suited one. The result cannot come out to be correct https://online-accounting.net/ if there are any mistakes in the Books of Accounts provided. A flexible budget depends very much upon a forecast of the past business performance. It can help in sales, costs, and profit calculation at different levels of operating capacity.

Therefore, in our next article, additional issues in the implementation of the flexible budgeting approach for measuring efficiency improvements will be explored. The last example is more complicated and more realistic of actual application .

Similarly, companies often face both fixed and variable components for environmental aspects. As with budgeting for cost, one needs to first budget separately for the fixed and variable components of the environmental aspect. However, compared to static budgeting, it doesn’t fix all target costs. Flexible budgeting takes into account each activity that makes performance measurement a better control. Flexible budgeting considers both fixed and variable costs with variance analysis. 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.

• Favorable variances are usually positive amounts, and unfavorable variances are usually negative amounts.
• If your expenses aren’t directly related to revenue, this budget model probably won’t work for you.
• In a static budget situation, this would result in large variances in many accounts due to the static budget being set based on sales that included the potential large client.
• Enter actual activity measures into the model after an accounting period has been completed.

If you don’t want to spend hours tracking and forecasting your budget in spreadsheets, check out our financial modeling tool. Finmark is everything you need to build an accurate, customized financial model. No matter which type of budget model you choose, tracking your finances is what matters most. You can work towards automating your budget since your expenses are directly tied to your revenue.

There were also fixed costs of $25,000 related to the factory and $25,000 related to selling and administration. 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.

Actual water usage is 8,900 gallons for plant A and 19,000 gallons for plant B. Water intensity in plant A decreases from 0.35 in year 1 to 0.32 in year 2. Once you have created your flexible budget, at the end of the accounting period you will want to compare the flexible budget totals against actuals. This comparison allows you to make any future adjustments based on the flexible budget variance indicated in the comparison. The initial estimate or static budget is a necessary part of planning. Creating a second, flexible budget allows a company to evaluate its actual performance during the static budget period. Budgets are a financial tool that forecasts business revenue and expenses over a specific period of time.