Flexible Budgeting

A static budget is typically based on a fixed level of activity or output and does not change with changes in sales volume, production volume, or other measures of business activity. It is often created at the beginning of the budget period and is not adjusted as the period progresses. A flexible budget is designed to change based on revenue or production levels.

What is the difference between a Flexible Budget and a Static Budget?

Instead, they have a massive amount of fixed overhead that does not vary in response to any type of activity. In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget. Flexible budgeting can be used to more easily update a budget for which revenue or other activity figures have not yet been finalized. Under this approach, managers give their approval for all fixed expenses, as well as variable expenses as a proportion of revenues or other activity measures. Then the budgeting staff completes the remainder of the budget, which flows through the formulas in the flexible budget and automatically alters expenditure levels. The flexible budget will show different possibilities for variable expenses and revenue.

Unlike a static budget, which is based on a fixed level of activity or output, a flexible budget is designed to be adaptable to changes in sales volume, production volume, or other measures of business activity. 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. At its simplest, the flexible budget alters those expenses that vary directly with revenues. There is typically a percentage built into the model that is multiplied by actual revenues to arrive at what expenses should be at a stated revenue level.

1. A flexible budget, while much more time-intensive to create and maintain, offers an incredibly precise picture of your company’s performance.
2. As shown in the above table, the accurate allowance is computed to be $8,880.
3. It’s versatile, adaptable, and can save your bacon when things get dicey.
4. 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.

What’s Flexible Budgeting?

Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases. A flexible budget is a budget that is created using a specific cost or formula. Unlike a static budget, a flexible budget includes both fixed and variable costs that can be adjusted based on revenue percentage or production cost incurred throughout the course of the budget period. In a nutshell, flexible budgets adjust based on revenue and cost changes throughout the year, accounting for the unexpected. Companies start by noting down fixed costs they expect to stay the same, then allow for variable costs to fluctuate, reviewing them periodically for real-time tweaks.

In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity. 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. You can also study the monthly adjustments and notes to more accurately plan for future costs. Creating a flexible budget begins with assigning all static costs a fixed monthly value, and then determining the percentage of revenue to assign to your variable costs.

Only then is it possible to issue financial statements that contain budget versus actual information, which delays the issuance of financial statements. While variances are noted in static budgets, a flexible budget allows you to enter the revenues and expenses relevant to that particular budget period, adapting flexible costs using real-time data. Unlike static budgets, flexible ones let businesses roll with the punches. Whether it’s a market shift, changing customer tastes, or internal tweaks, a flexible budget adjusts to keep the financial plan on track and relevant. Some companies have so bookkeeping to run your business few variable costs of any kind that there is little point in constructing a flexible budget.

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Flexible budgets take time to maintain, with routine monthly reviews and edits. It’s also important to request accountability for all changes made to this budget in order to keep it working for you. Flexible budgets are dynamic systems which allow for expansion and contraction in real time. They take into account that a business is an organic, growing system and that life is transactions not predictable. Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed for future periods.

A static budget is useful for providing a baseline for planning and evaluating performance, but it may not be as accurate as a flexible budget, especially in today’s business environment. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound. Your flexible budget would then look at revenue, based on both units sold and sales price.

While it’s possible that these costs will change slightly, most businesses simply budget for them upfront. 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%. Prepare a flexible budget for the three scenarios wherein the activity levels are 80%, 90%, and 100%. 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.

Within a flexible budget there are three types – or levels – of flexible budgets that can be created. A flexible budget is a budget that adjusts for changes in the level of activity or output. This makes the budget more up to date and accurate by keeping in mind unpredictability as much as possible.

Pros and Cons of Flexible Budgets

If an unexpected event does occur, changing the level of activity, the management will be better prepared. 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.

This means you’re not just reacting to problems but also grabbing opportunities by the horns. An alternative is to run a high-level flex budget as a pilot test to see how useful the concept is, and then expand the model as necessary. Let’s say a hamburger restaurant 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.

Only the purely variable expenses vary proportionately with the activity level. Budgetary control is the comparison of the actual results against the budget. Where the actual level of activity is different from that expected, comparisons of actual results against a fixed budget can give misleading results. Keep in mind that if you or your bookkeeper are unfamiliar with cost accounting, the process of creating a flexible budget is best left in the hands of an accounting professional or CPA. While preparing any budget at all is always better than not having one, a static budget does not prepare you for revenue and expense changes in real time.

You can funnel that extra cash into new products or beef up your marketing. On the flip side, if your revenue takes a nosedive, you can tighten the belt and cut back on expenses to keep things afloat. This kind of flexibility is gold, especially when everything around you is in flux.

The 3 Types of Flexible Budgets

These budgets are different in different levels of activities, which facilitate the ascertainment of fixation of cost, selling prices, and tendering of quotations. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.