Flexible Budgeting Process & Benefits What is Flexible Budgeting? Video & Lesson Transcript

A static budget–which is a forecast of revenue and expenses over a specific period–remains unchanged even with increases or decreases in sales and production volumes. However, when compared to the actual results that are received after the fact, the numbers from static budgets can be quite different from the actual results. Static budgets are used by accountants, finance professionals, and the management teams of companies looking to gauge the financial performance of a company over time. The flexible budget is a financial plan that is prepared to identify and adjust for changes in the volume of activity.

• The flexible budget at first appears to be an excellent way to resolve many of the difficulties inherent in a static budget.
• The business had planned to sell 25,000 units in 2022 at a price of $6.50.
• By keeping each department or division within budget, companies can remain on track with their long-term financial goals.
• That would mean the budget would fluctuate along with the company’s performance and real costs.
• 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.

Flexible budgeting is developed based on different sales levels, having the costs adjusted for any changes in volume. The business can then use the figures from the three budgets to create a new one for the following year. Costs that are below budget are good, as they are considered favorable as long as they implement the correct scenario for the volume. In Chapter 9, Using budgets to evaluate performance, we discussed the idea of a flexible budget – the restating of our original budget, but using the sales quantities that were actually recorded. The first is the static budget – our original budget – labelled static because it does not move or change.

Company

Flexible budgets are most appropriate for businesses that operate with an increased variable cost structure, where costs are primarily attached to activity levels. While creating and maintaining real-time adjustments can be somewhat time-consuming, there’s tangible value in terms of more efficient budget allocations and more agile decision-making. After each month (or accounting period) closes, a flexible budget assumes you’ll compare projected revenue to actual results and adjust the next month’s expenses accordingly. Flexible budgeting is an adaptable budgeting method that adjusts to changes in costs and revenue.

If that company produces 1,000 units and expects to make $4,000 but instead makes $4,200, then the variance would be $200. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. Creating a budget, even one that’s not constantly evolving, can be an overwhelming to-do on the never-ending checklist facing leaders of emerging businesses. Cash is the lifeblood of any business — and allocating it effectively is integral to success. But, in a happier scenario, what if the coffee shop exceeds expectations and operates at 120% of original expected activity?

Identify the Key Drivers of Financial Performance

Flexible budgets can be very useful, but they do have some downsides. Eliminate manual data entry and create customized dashboards with live data. Let’s suppose the production machinery had to operate for 4,500 hours during February.

Maybe you spent less on facilities than expected, but new tariffs mean manufacturing is not going to make its numbers. By investing what you would have spent on utilities and in-office food service on a one-time effort to find and sign on alternate suppliers, https://www.bookstime.com/articles/flexible-budget you set that team up for more predictable costs going forward. Growth rarely happens in exactly the way your original business plan described. All the forward-looking planning in the world can go right into left field in the face of, say, a global pandemic.

Difference Between Fixed and Flexible Budgets

Here’s a quick punch list of the pros and cons of flexible budgets. 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. Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. The flexible budget at first appears to be an excellent way to resolve many of the difficulties inherent in a static budget. However, there are also a number of serious issues with it, which we address below. If you’re constantly monitoring, you can reallocate funds on the fly.

• As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration.
• It consists of preparing multiple budget scenarios which are then adjusted for different volumes.
• The following steps or stages are involved in the preparation of flexible budget.
• What’s more  important is to apply the principles to certain parts of your budget.
• If a SaaS company is forecasting its cost of benefits, it might tie the budget line item to its headcount forecast.

Nothing ever stays the same, and management has the responsibility to respond to unanticipated adverse conditions and to take advantage of unexpected opportunities. 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. Your flexible budget would then look at revenue, based on both units sold and sales price. For example, your flexible budget may have three columns that show the number of units sold, the sales price, and total revenue. The formula for calculating a fixed budget is rather simple and straightforward.

How to Prepare a Master Budget for a Business

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. The flexible budget for the quarter would reflect both these things.

By taking into account changes in sales volume, production levels, or other factors, a flexible budget can provide a more realistic picture of the company’s financial performance. With flexible budgets, it’s easy to make updates to revenue and activity figures that haven’t been finalized. Because of these seamless workflows (and because of the inherent adaptability), flexible budgets give way to more efficiency than their fixed budget counterparts. 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.

Flexible budget – example

Collaborative software like Microsoft Teams or Slack can help FP&A teams collaborate effectively with other departments during budgeting. These tools enable real-time communication and file sharing, which can help ensure that everyone has the most up-to-date information. FP&A teams should use historical and relevant information to set natural fields for each activity driver. In other words, you can take a favorable variance in one category of your budget, and apply it to another flexible budget variance in hopes of producing more profit. If the budget is built on a certain production level, and production volume changes significantly, resources can’t easily be reallocated to account for the change.

Whether switching to a flexible budgeting process from a static model or starting from scratch, there are keys to success. Develop reporting systems that track and compare actual activity and budgeted levels. It will enable FP&A teams to identify variances and adjust the budget accordingly. A flexible budget can hold managers accountable for their performance.

Doesn’t Apply to All Line Items

Only then is it possible to issue financial statements that contain budget versus actual information, which delays the issuance of financial statements. A flexible budget can https://www.bookstime.com/ be created that ranges in level of sophistication. In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity.

• These variances are used to assess whether the differences were favorable (increased profits) or unfavorable (decreased profits).
• With flexible budgets, it’s easy to make updates to revenue and activity figures that haven’t been finalized.
• There will be discrepancies between the budgeted amount and the actual spending amount, especially if you deal with fluctuating costs of raw materials or the cost of goods sold.
• There is no way to highlight whether actual revenues are above or below expectations.
• For example, let’s say that you have been asked to create an operating plan for your business over the next five years.
• 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.