What is a Flexible Budget? Definition Meaning Example

Once this data is collected, it is compared to the flexible budget figures. The difference between the actual results and the flexible budget figures is the variance. Positive variances indicate better-than-expected performance, while negative variances suggest areas where performance fell short.

• This allows businesses to set more realistic financial targets and make informed decisions.
• Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement.
• Variable cost, like raw materials and labor, fluctuate with production levels, impacting the variable cost ratio.
• This dynamic financial planning tool adjusts to reflect actual activity levels, providing a more realistic benchmark for performance evaluation.

Step 1: Analyze Financial History and Categorize Costs

• This allows the variable cost per unit to be applied to different activity levels, while total fixed costs are included as a constant.
• A basic budget has been defined as a budget which is prepared for use unaltered over a long period of time.
• Choose the metric that best drives your costs and revenues throughout your business operations.
• The predictability of a static budget can be reassuring for stakeholders who want to see exactly how you’ll allocate funds.

Predictable expenses like parts, labor, tools, and materials are used in various types of projects and can help you determine whether you need to cut costs or have more flexibility in your budget. Any business with predictable expenses can benefit from a static budget because they already know how much it will spend in a given period. In addition, by knowing a hard number you can’t go over, a static budget can prevent you from making financial mistakes that often plague small businesses and startups. Discover how to choose between a static and flexible budget for your business. Understand the advantages and disadvantages of each budgeting approach to make a decision.

Your Money, Your Rules

The main components of a flexible budget are fixed costs, variable costs, and revenue expectations that adjust according to different levels of business activity. This structure allows for better financial planning and performance evaluation. Mixed costs contain both fixed and variable components, such as a utility bill with a fixed service charge and a variable charge based on consumption.

Why Businesses Adopt Flexible Budgeting

This budget is defined as a budget which is prepared for period less than a year and is very useful to lower levels of management for control purposes. Such budgets are prepared for those activities, the trend in which is difficult to foresee over longer periods. Where the undertaking is suffering from shortage of a factor of production such as materials, labour, plant capacity etc. The level of activity depends upon the availability of such a factor of production. In this article, we’ll explain how flexible budgeting works, when to use it, its pros and cons, and how to build one for your organization.

Example of a Flexible Budget

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. The next step is determining the variable cost per unit for each expense category. This requires analyzing historical data and cost drivers to establish how much each variable cost increases per additional unit of activity. For example, if direct materials cost $5 per unit, this rate applies across all activity levels. Flexible budget variance is also possible but occurs when flexible budget there’s a difference between the budgeted and actual expenses rather than actual sales volume.

Disadvantages of flexible budgeting

This means considering external factors such as market trends, economic conditions, and competitive actions that could have influenced the variances. By understanding these external influences, businesses can better interpret their variance results and make more informed decisions. Spending variance, also known as cost variance, examines the difference between the actual costs incurred and the budgeted costs.

Price variance occurs when the actual price of inputs differs from the budgeted price, while quantity variance arises from differences in the actual quantity of inputs used versus what was budgeted. By dissecting these variances, businesses can pinpoint specific areas that need attention, whether it’s negotiating better prices with suppliers or improving operational efficiency. Static budgeting is constrained by the ability of an organization to accurately forecast its needed expenses, how much to allocate to those costs and its operating revenue for the upcoming period.

Products

Flexible budget recognises concept of variability and provides logical comparison of expenditure with actual expenditure as a means of control. Its production equipment operates, on average, between 3,500 and 6,500 hours per month. For control purposes, the accountant then compares the budget to actual data. We prioritize your safety by using the most advanced security technology to protect your personal data.

If you could split one dollar proportionally across those costs, how would you do so? If your company experiences significant seasonal fluctuations, flexible budgets can be incredibly valuable. They allow you to plan for predictable variations without constantly revising your entire budget.

But if demand surges to 1,500, you may need to hire additional employees. What’s important is that there’s an established logic behind what you’re using to measure sales activity and the costs that will “flex” based on it. An e-commerce shop that sells socks could look at units sold while a lawncare company could look at completed projects.

Your sales might be soaring high one month and incredibly low the next, especially if you’re just starting out. Therefore, if a company has a revenue of $500,000, it allocates 100,000 towards various marketing campaigns like social media, email marketing, paid traffic ads, and traditional marketing strategies. A leveraged buyout (LBO) is a transaction in which a company or business is acquired using a significant amount of borrowed money (leverage) to meet the cost of acquisition. Analyzing the cost variances may be tricky as the nature of the total expenditures may not be similar. The equipment in the factory operates for 3000 to 5000 hours on an average monthly. Firm A is looking to determine the supplies and electricity costs, with a $20 cost per machine hour plus a fixed cost of $45000.