7 4: Prepare Flexible Budgets Business LibreTexts

This shows that while sales increased, variable expenditures per unit were higher than expected—possibly due to rush shipping using debit and credit or material price increases. Summer brings higher electricity bills, and winter brings heating costs. A static budget works well when operations are predictable. A static budget stays the same throughout the entire period, no matter what happens.

What is a Flexible Budget? (Advantages & Formula)

There are also task management, resource management and risk management features that help you stay productive and keep to your budget and deliver on time. Our real-time reporting features allow you to capture live data on cost, time and many more metrics with just a couple of keystrokes. This captures your plan and allows you to track your progress in real time by comparing the actual progress against your planned progress. Once you have all your costs and resources scheduled, set a baseline. ProjectManager is award-winning project management software that helps you plan, manage and track your budget in real time.

The advantage to a flexible budget is we can create abudget based on the ACTUAL level of production to give us a clearerpicture of our results by comparing the flexible budget to actualresults. Notice how the variable costs changewith volume but the fixed costs remain the same. Aflexible operatingbudget is a special kind of budget that providesdetailed information about budgeted expenses (and revenues) atvarious levels of output. It’s a plan of sorts for how an organization spends its money over a period, including revenue, fixed cost and variable costs. 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. Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter.

Quest Adventure Gear has always budgeted for sales of its polycarbonate climbing helmets using a static budget, but sales have differed markedly from expectations, resulting in large variances in its production budget.
Flexible budgets are prepared at the end of each analysis period (usually monthly), rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level.
Incorporating flexible budgets into routine financial reviews can lead to more accurate assessments of business performance.
That’s okay, as long as you aren’t overspending on your budget as a whole or making the extras in life a priority over the necessities.
Fixed costs + (Variable cost per unit × number of units)
Early in the chapter, you learned that a budget should be adjusted for changes in assumptions or variations in the level of operations.
As an example, take a company with a master budget that projects production of 10,000 units.

A flexible budget is usually created and adjusted based on the actual results, whereas a fixed budget will remain the same regardless of how well or poorly things are going. A flexible budget is a budget that can be changed, unlike a fixed budget. As you can see, the flexible budget indicates we should have made $16,600 in profit, a more reasonable number than $42,500 given the decrease in sales by 7,000 units. We can then compare our static budget, flexible budget and actual. Utilize the calculator above to input your values and see how different costs and activity levels affect your total costs and profits.

They simplify variance analysis with features like real-time reporting, automated data integration, and advanced forecasting. It helps you stay on top of performance by comparing actual results to updated forecasts, which gives you clear insights into how efficiently your business is running. When this company exceeded its budget, breaking the variances into price and efficiency factors helped clarify the situation. The company acquired 200 more customers than budgeted, leading to an unfavorable efficiency variance of $10,000, because it had to spend more on customer acquisition than initially planned.

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. This approach varies from the more common static budget, which contains nothing but fixed expense amounts that do not vary with actual revenue levels. 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.

Step Cost Development is Time-Consuming

Let's look at how a flexible budget works in practice using ACME Corp., a small company that makes widgets. Large variances might signal pricing issues, efficiency problems, or unexpected cost changes that require investigation and corrective action. Variable costs multiply your per-unit rate by the activity driver. Common activity drivers include units produced, direct labor hours, machine hours, sales volume, or customers served. Flexible budgets range from simple to complex, each designed to match your business's needs and analytical capabilities. A static budget won't account for these variations, potentially leading to inaccurate financial planning.

Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter.
For a personal budget, it could mean adjusting entertainment spending based on monthly income.
When you have a flexible budget, you can be more creative with your spending.
We have noticed that the recovery rate (Budgeted hrs/Total expenses) at the activity level of 70 % is $0.61 per hr.
Common activity drivers include units produced, direct labor hours, machine hours, sales volume, or customers served.

Calculating Flexible Budget Variance Made Easy

The company knows its variable costs per unit and knows it is introducing its new product to the marketplace. If production is higher than planned and has been increased to meet the increased sales, expenses will be over budget. Therefore, you should always review your budget on occasion so that you can account for flexible budget variance with some degree of accuracy. It’s also important to understand the concept of flexible budget variance.

Static vs. flexible budget

In the dynamic world of business, where operational activities fluctuate in response to market demands, customer behavior, and process changes, budgeting approaches must be equally agile. While the total amount you spend on variable expenses will change, this percentage will always remain the same. This means your baseline variable expenses account for just under 27% of your expected revenue. It helps you understand how much of each dollar you earn is spent on costs that scale with sales volume. So if each piece costs $2 to ship, $1 for packaging, $2 for the raw materials, and an average of $3 in labor wages, your total variable cost per item would be $8.

They require more time and resources to maintain, which might not be feasible if you don’t have the capacity. For long-term planning, it can serve as a foundation for creating multi-year financial projections. Thus, it helps managers make informed decisions and improve budgeting processes. This way, they can understand the reasons for any variation in the actual results. This makes it perfect for looking into the differences between what was planned and what actually happened, helping managers see how different parts of the company performed.

A flexible operating budget is a special kind of budget that provides detailed information about budgeted expenses (and revenues) at various levels of output. Variable costs and unpredictable expenses make traditional static budgets obsolete almost as soon as you finalize them. The budget automatically scales up or down based on actual business activity, giving managers a realistic benchmark for evaluating performance at any production level. Combine your established formulas with projected activity levels to build a flexible budget.

But at the end of the month, you’re doing a final check to make sure you’ve still got that zero-based budget. You should do this any time it’s needed as you track your transactions. That’s okay, as long as you aren’t overspending on your budget as a whole or making the extras in life a priority over the necessities. And plans don’t change.

It also considers multiple variables, including changes in production volumes, sales mix, price levels, and other complex factors. A flexible intermediate budget considers changes in costs based on such other activity measures. It typically adjusts the budgeted figures for one or a few key variables, such as sales volume or production levels. Let us see a few examples of how to calculate flexible budgets and how to perform variance analysis. The advantage to a flexible budget is we can create a budget based on the ACTUAL level of production to give us a clearer picture of our results by comparing the flexible budget to actual results. Notice how the variable costs change with volume but the fixed costs remain the same.

An actual flexible budget could be prepared using two or more scenarios (although more than three might not add to the usefulness) and could be presented in much more detail. The advantage of comparing actual results to the flexible budget is that it helps pinpoint inaccuracies in the master budget. Before costs can be added in, they should be classified correctly as variable or fixed. Activity variances can help explain how revenue was affected by changes in sales volume. All other costs shown in the budget are fixed. 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.

Just like life, the phases of the moon, and the fame of child actors, budgets change. As you track expenses, change budget line totals (those planned amounts) when needed so you keep a zero-based budget. We’re powerful project management software that can help you track your costs in real time.