Flexible budgets, to state the obvious, help companies be more flexible with their spending. It’s often mentioned in the same breath as the static budget, which is based on a fixed level of activity or output. Flexible budgets do not fix variances, they help to better plan for the future. Revenue is still calculated at month end so costs cannot be retroactively adjusted. With a flexible budget model, if your demand suddenly triples, your cost of goods sold (COGS) can be adjusted by a predetermined percentage ensuring that you have the cash to fill these orders. The more sophisticated relative of the static budget model, a flexible budget allows for change, and as we’ve said – business can be unpredictable.
In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity. Once you have how your variable costs vary as business activity changes, you will now need to create your budget. This Certified Bookkeeper includes revenue, expenses, and the key activity metrics you defined earlier. Accurate data collection is vital for making real-time adjustments to your budget. Use accounting software or spreadsheets to track this information efficiently.
Additionally, variable costs, like inventory and utilities, are projected at $5,000 for an assumed activity level of 1,000 customers. These advantages collectively empower a business to respond swiftly to changes, optimize resource utilization, and make well-informed financial decisions. By accommodating changes in activity levels, flexible budgeting enhances financial management practices and supports more accurate forecasting and planning. While creating and maintaining real-time adjustments can be somewhat time-consuming, there’s tangible value in terms of more efficient budget allocations and more agile decision-making. After each month (or accounting period) closes, a flexible budget assumes What is Legal E-Billing you’ll compare projected revenue to actual results and adjust the next month’s expenses accordingly.
Components of a Flexible Budget
- Among all, the one closer to the actual activity is to be considered.
- You can also study the monthly adjustments and notes to more accurately plan for future costs.
- Flexible budgets have a reputation for being more time-consuming than other budgeting models.
- Fixed costs remain constant regardless of activity levels, while variable costs fluctuate with changes in production or sales.
- In its simplest form, the flex budget uses percentages of revenue for certain expenses, rather than the usual fixed numbers.
For example, companies producing large volumes of goods in a stable and mature market may want to use a flexible budget to ensure that they are constantly producing and planning based on their actual sales volumes. In other words, unlike a static budget that remains fixed for a period of time, the flexible budget figure will vary as the actual results are determined. Use the insights from your variance analysis to make operational adjustments.
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. Companies that like to have a budget that is very close to activity levels will want to use a flexible budgeting system to ensure they are planning as best as possible to the actuals. While flexible budgets are often used for manufacturing overhead, they’re also pretty common for SaaS businesses. If a SaaS company is forecasting its cost of benefits, it might tie the budget line item to its headcount forecast. So as headcount increases, the cost of benefits also increases according to the per-employee assumption. Sales has a budget, marketing has a budget, product has a budget, and so on.
- If certain costs are consistently higher than expected, investigate the reasons and take corrective action.
- Flexible budgets calculate, for example, different levels of expenditure for variable costs.
- Although there are important benefits to using flexible budgets, you should also be mindful of its drawbacks.
- A company may use flexible budgets to account for the variable costs in the operation of a plant or equipment.
Provides Optimal Usability in Variable Cost Environments
It also knows that other costs are fixed costs of approximately $40,000 per month. Typically, the machine hours are between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. A flexible budget can be created that ranges in level of sophistication.
Own the of your business.
- Most flexible budgets use a percentage of projected revenue to account for variable costs rather than assigning a rigid numerical value at the start.
- Flexible budgets come with advantages like their usability in variable cost environments, their detailed picture of performance, and their overall efficiency for budgeting teams.
- Then, you’ll need to analyze your variable costs to identify what triggers variability in these costs.
- A Flexible Budget is a budget that adjusts or flexes with changes in the volume of activity.
These budgets are different in different levels of activities, which facilitate the ascertainment of fixation of cost, selling prices, and tendering of quotations. 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.
What is a flexible budget: definition, examples, and best practices
This allows for budget adjustments to occur in real-time, taking into account external factors. 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. Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance. A great deal of time can be spent developing step costs, which is more time than the typical accounting staff has available, especially when in the midst of creating the more traditional static budget.
For example, the cost of goods sold varies based on production levels or sales figures. Then, you’ll need to analyze your variable costs to identify what triggers variability in these costs. If the company’s revenues increase, the company should ensure that it increases its labor capacity to meet the demand but ensure not to exceed 30% of the overall spend. With a flexible budget, your budget is continually pegged to your actual figures. Thousands of people have transformed the way they plan their business through our ground-breaking financial forecasting software.
Flexible Budgeting 101: What Is It & How Does It Work?
Its production equipment operates, on average, between 3,500 and 6,500 hours per month. My Accounting Course is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Managers are busy and companies need to operate, spending too much time on developing a budget may not be feasible in all instances.
Advantages of flexible budgeting
This budget is divided into variable cost and fixed cost components, with the variable costs being tied to the number of unit sales of the helmet. The resulting budget is shown in the following table, which notes both budgeted and actual results for the first month of the budget period. A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses.
Another reason why flexible budgets are used is to evaluate company managers’ performance. Flexible budgeting can also tie into anything related to headcount (like employee benefits and salaries). As it turns out, the ability to respond to the actual performance of your company can be useful for maintaining the status quo and for growing faster than expected.