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. The ability to provide flexible budgets can be critical in new or changing businesses where the accuracy of estimating sales or usage my not be strong. For example, organizations are often reporting their sustainability efforts and may have some products that require more electricity than other products. The reporting of the energy per unit of output has sometimes been in error and can mislead management into making changes that may or may not help the company. Within an organization, static budgets are often used by accountants and chief financial officers (CFOs)–providing them with financial control. The static budget serves as a mechanism to prevent overspending and match expenses–or outgoing payments–with incoming revenue from sales.
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 not predictable. After each month (or set period) closes, you compare the projected revenue against the actual revenue and adjust the next month’s expenses accordingly.
Too much flexibility can limit FP&A’s ability to plan
It is often created at the beginning of the budget period and is not adjusted as the period progresses. 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. A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses.
Since a flexible budget empowers the finance team to think ahead and rein in spending under certain scenarios, it gives the finance team much more robust cost controls. A positive (or favorable) flexible budget variance number means you came in “above plan,” while a negative (or unfavorable) number means you weren’t as profitable or you spent more than you expected. 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.
Flexible Budget
If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue. A flexible budget, https://www.bookstime.com/ 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.
However, before deciding to switch to the flexible budget, consider the following countervailing issues. Static budgets are often used by non-profit, educational, and government organizations since they have been granted a specific amount of money to be allocated for a period. At first, you need to analyze the range under which the activity is expected to fluctuate. 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.
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A flexible budget, by its nature, will account for unforeseen expenses to some degree. While the magnitude of the unforeseen expense(s) might not align with what you’ve created in the budget, the path you’ve laid out for the business will in many cases be applicable, with some adjustments to the raw numbers. As it turns out, the ability to respond to the actual performance of your company can be useful for maintaining the status quo and for growing faster than expected.
Of the $4 million in budgeted cost of goods sold, $1 million is fixed, and $3 million varies directly with revenue. Thus, the variable portion of the cost of goods sold is 30% of revenues. Once the budget period has been completed, ABC what is a flexible budget finds that sales were actually $9 million. 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.