What is a flexible budget? Definition and example

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what is a flexible budget

This is the simplest form of a flexible budget, and it alters those expenses that vary directly with revenues. For example, finance can build a percentage into the basic flexible model, which they multiply by actual revenues to determine the expenses at a specified revenue level. It doesn’t provide the full level detail that a flexible budget would, but it does provide flexibility and a more accurate, up-to-date budget than a static budget. The benefit of a flexible budget is that it provides a more accurate picture of a business’s performance by adjusting for changes in activity levels. This can help businesses make better decisions about their operations, identify areas where they can improve efficiency or reduce costs, and better plan for future growth. In an unpredictable financial world, flexible budgets are helpful in manufacturing industries where costs change with a change in activity level.

what is a flexible budget

Flexible budget variance is any difference between the results generated by a flexible budget and actual results from following that budget. A flexible budget provides guidelines for a company to change their operations—to invest or divest in business practices—based on some external factor, typically revenue from those activities. With a flexible budget, assuming you’ve created a scenario where there’s an unforeseen expense, you have a plan to follow.

More efficient budgeting process

By incorporating these changes into the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity. If such predictive planning is not possible, there will be a disparity between the static budget and actual results. In contrast, a flexible budget might base its marketing expenses on a percentage of overall sales for the period.

3 Ways to Bring Flexibility to Budgeting – HBR.org Daily

3 Ways to Bring Flexibility to Budgeting.

Posted: Wed, 28 Sep 2022 07:00:00 GMT [source]

In a flexible budget, there is no comparison of budgeted to actual revenues, since the two numbers are the same. The model is designed to match actual expenses to expected expenses, not to compare revenue levels. There is no way to highlight whether actual revenues are above or below expectations. A flexible intermediate budget takes into account expenses that go beyond a company’s revenue. While even a static budget is better than no budget at all, creating a flexible budget provides a much clearer picture of revenues and production costs. If you own an ice cream shop, you know that the height of your business will be in the warm summer months.

Flexible budget – example

If you do find yourself in the market for accounting software for your small business, be sure to check out The Ascent’s accounting software reviews and find an application that is a good fit for your business needs. Managers are busy and companies need to operate, spending too much time on developing a budget may not be feasible in all instances. Now that you’ve mapped your numerous scenarios, it’s time to assign some budget numbers and parameters. This is more of an art than a science, but you should begin by prioritizing via a conservative budget and then layering on more convenient or superfluous expenses. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration. Flexible budgets work by taking the pressure off to predict future happenings.

  • Static budgets are often used by non-profit, educational, and government organizations since they have been granted a specific amount of money to be allocated for a period.
  • Also, temporary staff or additional employees needed for overtime during busy times are best budgeted using a flexible budget versus a static one.
  • If you’ve decided that a flexible budget is the right path for your organization, here’s how to successfully implement one.
  • While even a static budget is better than no budget at all, creating a flexible budget provides a much clearer picture of revenues and production costs.
  • With a flexible budget, it’s easy to show that while costs for a month might have been much higher than budgeted, so were sales – justifying the increase.
  • A flexible budget on the other hand would allow management to adjust their expectations in the budget for both changes in costs and revenue that would occur from the loss of the potential client.

If the factory has to use more machine hours one month, its budget should logically increase. Conversely, if it uses them for fewer hours, its budget should reflect that decline. Its production equipment operates, on average, between 3,500 and 6,500 hours per month.

Flexible budget: everything you need to know

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 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.

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia. The material provided on the Incorporated.Zone’s website is for general information purposes only. No lawyer-client, advisory, fiduciary or other relationship is created by accessing or otherwise using the Incorporated.Zone’s website or by communicating with Incorporated.Zone by way of e-mail or through our website. Ambitious finance leaders engage with Prophix to drive progress and do their best work.

A fixed budget is one that stays the same and doesn’t change based on variable costs. Flexible budgets change based on fluctuations with variable costs and have the ability to expand or contract in real time. It begins with a static framework built from the costs that are not anticipated to change throughout the year. Layered on top of that is a flexible budget system allowing for variable costs to what is a flexible budget fluctuate based on sales performance. 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.

For example, a company with a large seasonal variation should have a flexible budget to account for the increase and drop in supply and demand according to the seasonality. Say a company’s paid advertising channel is performing well and generating more revenue than was expected. A flexible budget gives the company the green light to reinvest more of that revenue back into the channel. Flexible budgets are dynamic systems which allow for expansion and contraction in real time.

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