What Is Flexible Budgeting? Tips & Example

Because of this, there are several different types of budgeting systems that can be used. Note that fixed expenses and variable cost ratios didn’t change, because they don’t vary based on activity. However, variable expenses shifted considerably based on the number of customers, warranting the extra monitoring and maintenance.

For SaaS companies, flexible budgeting relates more to the cost of revenue — the actual costs for creating and delivering a product/service to customers. The cost of revenue involves hosting fees, service and cloud fees, and website development. Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information. When preparing budget reports, it is important to include in the report the items the manager can control. If a manager is only responsible for a department’s costs, to include all the manufacturing costs or net income for the company would not result in a fair evaluation of the manager’s performance.

Using this budgeting process is more effective since it provides a realistic outlook on the projected budget. Using the cost data from the budgeted income statement, the expected total cost to produce one truck was $11.25. The flexible budget cost of goods sold of $196,875 is $11.25 per pick up truck times the 17,500 trucks sold.

Definition and Examples of a Flexible Budget

We provide example budgets, pros and cons and a guide to getting started. Flexible, rolling budgets empower entrepreneurs to cope with change. Brainyard delivers data-driven insights and expert advice to help businesses discover, interpret and act on emerging opportunities and trends. Sales increase, but commissions do not increase at a similar rate, since the commissions are based on cash received, which has a 30-day time lag. Let’s suppose the production machinery had to operate for 4,500 hours during February.

In conclusion, the budget that companies can prepare for multiple output levels is a Flexible Budget. Practically, managers widely use this type of budget as it is the most realistic one. Flexible Budget Variance is the disparity between the actual and budgeted output, costs and standards. The reason is that budgets are the forecasts for future activities. And the actual output may be more or less than the budgeted ones.

Business is Our Business

Income taxes are budgeted as 40% of income before income taxes. The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250. Actual expenses are lower because the income before income taxes was lower.

It allows Illinois income tax rate to prepare budgets under different scenarios to be adjusted for future projections. For example, your flexible budget may have three columns that show the number of units sold, the sales price, and total revenue. Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes. So if the initial static budget called for 25% to be spent on marketing, the flexible budget will maintain that same percentage for marketing whether the budget increases or decreases. A flexible budget is much more realistic than fixed budget since it gives emphasis on cost behavior at different levels of activity.

How do we create a flexible budget?

If it used a flexible budget, the fixed portion of the cost of goods sold would still be $1 million, but the variable portion would drop to $2.7 million, since it is always 30% of revenues. The result is that a flexible budget yields a budgeted cost of goods sold of $3.7 million at a $9 million revenue level, rather than the $4 million that would be listed in a static budget. Flexible budgets have the ability to constantly restructure themselves around changes in activity. This adaptability allows flexible budgets to offer a precise picture of company performance, seeing as they’re always working with the most current data and details. What is not known from looking at it is why the variances occurred.

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. Using a flexible budget allows you to account for increased revenues, higher labor costs, and higher inventory costs during the busier months without having to adjust for months when business is slower.

• The columns would continue below with fixed and variable expenses, allowing you to see how your net profit changes based on changes in actual production and revenue.
• The reason is that budgets are the forecasts for future activities.
• This nimble planning process lets you adjust spending throughout the year; benefits include less overspending, more opportunities and speedier responses to changing market and business conditions.
• At 50% capacity, the cost of working raw materials increases by 2% and the selling price falls by 2%.
• This ability to change the budget also makes it easier to pinpoint who is responsible if a revenue or cost target is missed.

Companywide financial data is kept in one centralized and up-to-date location, offering greater visibility over financial plans, forecasts and budgets. This also makes budget monitoring and maintenance an easier and more collaborative process. Enter actual activity measures into the model after an accounting period has been completed.

Company

Companies develop a budget based on their expectations for their most likely level of sales and expenses. Often, a company can expect that their production and sales volume will vary from budget period to budget period. They can use their various expected levels of production to create a flexible budget that includes these different levels of production. Then, they can modify the flexible budget when they have their actual production volume and compare it to the flexible budget for the same production volume. A flexible budget is more complicated, requires a solid understanding of a company’s fixed and variable expenses, and allows for greater control over changes that occur throughout the year. For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier.

Fixed expenses such as rent, utilities, equipment costs, and salaries usually make up a significant portion of any business budget. While it’s possible that these costs will change slightly, most businesses simply budget for them upfront. A flexible budget can be a useful resource for business owners struggling to properly budget around variable costs. If you manufacture products, see how a flexible budget can help your business. Operations managers that have limited or unplanned resources may not be physically able to adjust for revised activity levels or production. Better yet, when you have real-time budget visibility, you can forecast or update your budget and see those updates reflected on other key metrics that matter to your business.

• If the financial needs of a factory, for example, change regularly, a flexible budget makes more sense.
• He is the sole author of all the materials on AccountingCoach.com.
• If a SaaS company is forecasting its cost of benefits, it might tie the budget line item to its headcount forecast.
• A flexible budget can be a useful resource for business owners struggling to properly budget around variable costs.
• A flexible budget will show the variance in both revenue and spending.

This flexibility allows management to estimate what the budgeted numbers would look like at various levels of sales. Flexible budgets are prepared at the end of each analysis period , rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level. Flexible budgets are prepared at each analysis period , rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level. A company makes a budget for the smallest time period possible so that management can find and adjust problems to minimize their impact on the business.

In addition, NetSuite makes it possible to run what-if scenarios to help you see what could happen in the best- and worst-case scenarios. It also includes predictive analytics and planning capabilities that let you compare various situations ad hoc. Dashboards make it easy to dig deep into areas like budget, forecasts and actuals to glean detailed insights about business performance and better inform the decision-making process. Once you identify fixed and variable costs, separate them on your budget sheet.

Optimal Usability in Variable Cost Environments

However, to see these numbers in action, let’s say, hypothetically, a pandemic hits. The coffee shop’s activity is then reduced to 70% of what was expected. As opposed to 22,750 customers, there are only 15,925, bringing revenue down to $47,775. It can also be calculated as per-unit variable cost over the per-unit sales cost, or $.75 / $3.

He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University. Suppose the budget was set up with the expectation that sales would be $200,000 per month and labor cost was budgeted at $50,000 per month, or 25 percent of sales. 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. While there is not specific equation or formula for the flexible budget, it uses the same basic method.

Static versus Flexible Budgets

A static budget would not adjust to the decline in revenues and would keep labor costs at the original level. As with any budget, flexible budgets are simply forecast that may change by the time production actually begins. Budgeting gives companies useful information ahead of time that can help them plan better. The flexible budgeting approach can adjust to variances quickly and provide better controls and operations. The biggest advantage of flexible budgeting is the stress on operational efficiency required to achieve the target. It’s important to note that your actual results will always be different from the planned target.

Everything starts with the estimated sales, but what happens if the sales are more or less than expected? What adjustments does a company have to make in order to compare the actual numbers to budgeted numbers when evaluating results? If production is higher than planned and has been increased to meet the increased sales, expenses will be over budget. To account for actual sales and expenses differing from budgeted sales and expenses, companies will often create flexible budgets to allow budgets to fluctuate with future demand. A flexible budget is prepared after the end of the budget period. The type of budget shows the business what the static budget should have been by using the actual numbers from the budget period.

You can use a budget to plan for various activities or departments within a business. Budgets offer planning and control measures for an organization, and will always vary slightly from actual sales and actual output. Flexible budgets have a reputation for being more time-consuming than other budgeting models. That’s because flexible budgets require continual upkeep and maintenance — you’re constantly having to keep an eye out for fluctuations and then execute those changes as quickly as you can. While this isn’t a reason to avoid flexible budgeting altogether, it’s good to keep in mind as you consider how and when to implement this kind of budgeting strategy.

Let’s say Green Company estimates their total production capacity to be 250,000 units. The direct material and labor costs per unit are $4.50 and $2.50 respectively. The company offers sales incentives to their sales force of 5% of sales. The difference between a flexible budget and a static budget is that static budgets deal with fixed budget amounts that don’t vary as other line items increase and decrease.