Flexible approach of budgeting can adjust to the variances quickly and result in better controls in operations. The biggest advantage with flexible budgeting is the stress on operational efficiency to achieve the standard targets. A Flexible budgeting performance report is the one that analyzes the actual results against the standard budgets. A positive variance means the company produced favorable results and achieved higher efficiency than planned. An adverse variance means the company failed to achieve the target or standard plans. As the budget can be made for any activity, the variance should also be analyzed separately for these activities.

In the world of business, there’s a critical distinction between different types of profit that can impact decisions at every level. Year-over-year (YOY) is a financial term used to compare data for a specific period of time with the corresponding period from the previous… The production target set by the company was 80,000 units but only 65,000 units were achieved, so this situation is said to be ineffective.

Identify fixed and variable costs

The variance analyses can help the management to understand the causes and cost drivers behind the change, positive or negative. The budget model multiplies the $21.50 budgeted unit cost of the helmet components by the 1,500 actual units sold to arrive at budgeted variable costs for the month of $32,250. This means that variable or flexible cost of goods makes up 12% of a company’s revenue. At the end of the accounting period, Company B determines that its sales were actually $6 million, $1 million higher than expected. While preparing this budget is a simple affair, given the fixed costs involved in undertaking the calculations with respect to the business income, it lacks flexibility at the same time. No matter how positive the change in the sales volume of a business is, the budget would not undergo any change, even the minutest one.

Advantages of Flexible Budgeting

Compare your flexible budget amounts to actual results to identify variances. A variance is the difference between what you budgeted and what actually happened. Favorable variances occur when actual performance is better than budgeted, while unfavorable variances indicate worse performance. Analyzing these variances helps you understand where your assumptions were off and why.

Advantages of flexible budgeting

• A static budget won’t account for these variations, potentially leading to inaccurate financial planning.
• Flexible budgeting works well for manufacturing companies or companies that have revenues based on seasonality for instance.
• 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.
• However, this approach ignores changes to other costs that do not change in accordance with small revenue variations.
• Consequently, the flex budget tends to include only a small number of step costs, as well as variable costs whose fixed cost components are not fully recognized.
• A shoe making unit prepared a budget based on the expected sales volume and average output of the manufacturer.

Let’s say a hamburger restaurant flexible budget definition has a fixed budget of $10,000 for expenses for the month, which is based on an a certain number of expected customers. However, the restaurant experiences a significant increase in customer traffic during the first week of the month, resulting in higher food costs. Thus, if the actual expenses exceed $8,880 by $X in the month with an 80% activity level, it would mean that the company has not saved any money but has overspent $X more than the budgeted amount. The types decide the flexible budget format applicable in different scenarios. While the basic flexible budget is prepared, indicating how the expenses are completely in sync with the revenues generated, the intermediate type reflects the expenses beyond what is generated as revenue. Budgetary control is the comparison of the actual results against the budget.

Across the landscape of financial planning and management, businesses often encounter fluctuations in their financial and operations variables. A key tool can come into play to help navigate these uncertainties and make better informed decisions – the flexible budget. In activity-based flexible budgeting, the process of allocating funds is carried out by the business by first identifying the main activities to achieve business goals. The company then calculates costs and creates additional budgets based on activity. This can also minimize the incurrence of debt when carrying out specified activities. Simply put, it is how a business calculates its budget, estimates its needs, and how many goals the business wants to achieve.

For more on managing budget-to-actual variance, consider these best practices. This 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. This reduces the reliance on guesswork and enhances the overall decision-making process. When you see how actual results compare to the flexible budget, you gain a clearer understanding of your financial situation.

The flexible budget approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels. This means that the variances will likely be smaller than under a static budget, and will also be highly actionable. The Flexible budgeting approach is more practical and realistic than static budgeting. The flexible budgeting variance analyses can be performed for each activity, offering valuable information on discrepancies in operations and planning. The choice between the two depends on business requirements for accuracy and adaptability versus the desire for a simpler budgeting process. In general, budgets are divided into 2 types, namely flexible budgets and fixed (static) budgets.

• Now let’s illustrate the flexible budget by using different levels of volume.
• By categorizing costs into fixed, variable, and semi-variable, you can adjust your budget to match actual activity levels, providing a more realistic financial picture.
• Now, between 85% and 95% of the activity level, its semi-variable expenses increase by 10%, and above 95% of the activity level, they grow by 20%.
• As you can see, the flexible budget adjusts the expected food expenses based on a higher cost per customer, resulting in an extra $1,500 in the overall budget.
• In our example, the company might have set a target of 90% production, revised it to 85% and still would have achieved a 75% production level.
• A financial manager must be able to find the difference between fixed costs and variable costs.

Analyze variances

For example, a company having a cost of goods sold of $5 million over total revenues of $10 million will assign a 50% percentage to account for variations in overall revenues. For example, the cost of goods sold varies based on production levels or sales figures. As such, as the revenues and expenses vary, the budget percentage used will provide a different budget output. We can calculate the flexible budget performance report based on different production level. Flexible budgets take into account any activity level; therefore the activity level can be different for any business. By aligning with strategic goals, financial forecasting software like Brixx enhances the flexibility and precision of budgeting, contributing to better decision-making.

This type of budget adjusts variable costs based on a single activity measure, like sales or production volume. When the accounting period ends, update your budget with actual sales and/or activity metrics. This will adjust the variable costs according to the exact data of the accounting period.

Types of flexible budgets

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. A flexible budget is typically created by identifying the various costs and expenses that vary with changes in activity levels and calculating the expected cost or expense for each level of activity. Flexible budget variances may be used to determine any shortcomings in actual performance during a given period. Flexible budget variances are simply the differences between line items on actual financial statements with those on flexed budgets. Since the actual activity level is not available before the accounting periods closes, flexed budgets can only be prepared at the end of the period. Financial forecasting software is well-suited for managing flexible budgeting.

Management can do this by comparing each budgeted figure with the performance statistics achieved so that improvements can be seen and areas for improvement can also be identified. Its production equipment operates, on average, between 3,500 and 6,500 hours per month. In the case of a typical business, if it is newly started, it becomes tough to predict the demand for the products/services accurately. The material provided on the Incorporated.Zone’s website is for general information purposes only. Though the flex budget is a good tool, it can be difficult to formulate and administer.

Lack of income comparison

The result is a budget that is fairly closely aligned with actual results. This approach varies from the more common static budget, which contains nothing but fixed expense amounts that do not vary with actual revenue levels. As a result, the company will be able to include an additional $120,000 in the variable cost of goods budget to account for the increase in sales. While a static budget remains the same when created at the start of a new year, a flexible budget takes into account reduced or increased costs and helps businesses make adjustments to compensate.

If your business environment is stable with predictable costs and revenues, a static budget might suffice. However, if you operate in a dynamic market, the benefits of real-time adjustments and accurate performance evaluations may outweigh the costs. Evaluate your specific needs and capabilities to determine if a flexible budget aligns with your financial goals and operational structure. For more insights, explore how to build a better budget tailored to your organization’s needs. For variable costs, use a per-unit cost multiplied by the number of units. For semi-variable costs, combine a fixed component with a variable component.

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. Consequently, the flex budget tends to include only a small number of step costs, as well as variable costs whose fixed cost components are not fully recognized. 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. Create your budget by establishing fixed costs that will not change and variable costs expressed as a percentage that can be adjusted based on actual sales. This type of budget takes into account expenses that exceed the company’s income.

If 5,000 machine hours were necessary for the month of January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the machine hours in February are 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. As you can see, the flexible budget adjusts the expected food expenses based on a higher cost per customer, resulting in an extra $1,500 in the overall budget.