Why a Flexible Budget May Be a Good Option for Your Business

In the example above, we showed that the restaurant does a simple adjustment based on the increase in customers, which directly affects revenue. Though the flex budget is a good tool, it can be difficult to formulate and administer. One problem with its formulation is that many costs are not fully variable, instead having a fixed cost component that must be calculated and included in the budget formula. Also, a great deal of time can be spent developing cost formulas, which is more time than the typical budgeting staff has available in the midst of the budget process.

Implementing Flexible Budgets

1. The laborers’ availability is a critical factor for these types of companies.
2. 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.
3. The advanced budget, on the contrary, takes into consideration the expected variations and ranges of differences in expenses to be incurred.
4. In order to create an accurate business budget, you’ll need to separate fixed costs from variable costs since a flexible budget is only concerned with variable expenses, such as production levels, materials and labor.

The main difference between a flexible budget and a static budget is that a flexible budget adjusts to changes in activity levels, while a static budget remains the same regardless of changes in activity levels. For costs that vary with volume or activity, the flexible budget will flex because the budget will include a variable rate per unit of activity instead of one fixed total amount. In short, the flexible budget is a more useful tool when measuring a manager’s efficiency.

They let you update revenue and activity figures that aren’t set in stone yet, making budget allocations smoother and decisions quicker (Mosaic). This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue. A flexible budget, while much more time-intensive to create and maintain, offers an incredibly precise picture of your company’s performance. Due to the ability to make real-time adjustments, the results present great detail and accuracy at the end of the year. 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. This is because the fixed expenses don’t change irrespective of the activity level and the semi-variable expenses do change but not in proportion to the activity level.

Benefits of having a flexible budget for your small business

The flexible budget example below displays both the original static budget amount as well as a flexible budget based on increased production levels. Both static and flexible budgets are designed to estimate future revenues and expenses. By understanding the advantages and disadvantages of a flexible budget, businesses can make an informed decision about which budgeting approach is best for what is the working capital cycle wcc their needs. If so, one can integrate these other activity measures into the flexible budget model. 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. Fixed expenses such as rent, utilities, equipment costs, and salaries usually make up a significant portion of any business budget.

Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. Best practices include regular reviews and tweaks, analysing variances, setting realistic goals, involving stakeholders, and using tech to make the process smoother. Flexible budgeting isn’t just about rolling with the punches; it’s also about having a firm grip on your finances.

Step 3: Enter production levels based on actuals

Suddenly, there is only one company to meet demand for widgets, resulting in actual sales of 200 units per month. The actual revenue the widget company is taking in has doubled—but the production costs would also go up. A flexible budget is a budget that changes based on your actual production or revenue. Unlike a static budget, it adjusts your original budget projection in using your actual sales or revenue. Once you have created your flexible budget, at the end of the accounting period you will want to compare the flexible budget totals against actuals. This comparison allows you to make any future adjustments based on the flexible budget variance indicated in the comparison.

The Finmark Blog is here to educate founders on key financial metrics, startup best practices, and everything else to give you the confidence to drive your business forward. No matter which type of budget model you choose, tracking your finances is what matters most. Imagine your product goes viral on social media and gains unexpected popularity overnight, now there is a demand for 20 units next month, which would cost $20 to make. We have noticed that the recovery rate (Budgeted hrs/Total expenses) at the activity level of 70 % is $0.61 per hr. If the factory works hrs in a particular month, the allowances @ $0.61 will come put to be $9,760, which is not correct. As shown in the above table, the accurate allowance is computed to be $8,880.

For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. 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.

Accepting that we can’t predict the future, as hard as we might try, is a lesson everyone learned in recent years. Let’s face it  – business moves fast, and we have to be flexible for second stimulus bill what is thrown at us.

An advanced flexible budget adjusts for changes in activity levels for all costs, including both fixed and variable costs. This type of flexible budget takes into account how changes in activity levels affect all costs and provides the most accurate picture of expected costs at different levels of activity. Actual revenues or other activity measures are entered into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs. In order to create an accurate business budget, you’ll need to separate fixed costs from variable costs since a flexible budget is only concerned with variable expenses, such as production levels, materials and labor. A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses. In order to accurately predict the changes in costs, management has to identify the fixed costs and the variable costs.

If you manage a high-level production environment, creating a flexible budget can help mitigate the typical variances found on static budgets. In short, a flexible budget requires extra time to construct, delays the issuance of financial statements, does not measure revenue variances, and may not be applicable under certain budget models. Revenue and cost needs to be compared monthly and adjustments or notes should be made. Additionally, flexible budgets have a lack of accountability to some degree since they are so fluid and open to change. The more sophisticated relative of the static budget model, a flexible budget allows for change, and as we’ve said – business can be unpredictable. It is useful for both planning purposes and control purposes and is generally used to estimate factory costs and operating costs.

When diving into flexible budgets, it’s key to know the difference between fixed and variable costs. Flexible budgets let you adjust revenues and costs based on different activity levels, making it easier to budget within a range by figuring out which costs stay the same and which ones change. A flexible budget adjusts based on changes in actual revenue or other activities. 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.