What is Flexible Budget? Variance, Formula and Example

A static budget based on planned outputs and inputs for each of a company’s divisions can help management track revenue, expenses, and cash flow needs. Flexible budgets come with advantages like their usability in variable cost environments, their detailed picture of performance, and their overall efficiency for budgeting teams. It’s most common to update forecasted https://www.bookstime.com/articles/flexible-budget line items in a flexible budget following a monthly review of total costs and top-line growth. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound. 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.

Financial planning and analysis (FP&A) teams use this to understand better how business operation changes impact financial performance. Lobster Instant Noodles make instant ramen noodles in cups that are commonly eaten by university students across the world. Simply add boiling water, close the lid for 3 minutes and you’ve got an instant meal. The business had planned to sell 25,000 units in 2022 at a price of $6.50. There were direct variable costs for materials $0.80, labour $1.00, overhead $0.50 and selling and administration $0.50.

4 Flexible Budgets

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. And with out-of-the-box metrics, templates, and dashboards like the forecast vs. actuals dashboard, you can shorten the budget allocation and planning process from two weeks down to two days. No matter which type of budget model you choose, https://www.bookstime.com/ tracking your finances is what matters most. 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.

While flexible budgets are often used for manufacturing overhead, they’re also pretty common for SaaS businesses. If a SaaS company is forecasting its cost of benefits, it might tie the budget line item to its headcount forecast. So as headcount increases, the cost of benefits also increases according to the per-employee assumption. Let’s assume a company determines that its cost of electricity and supplies will vary by approximately $10 for each machine hour (MH) used. It also knows that other costs are fixed costs of approximately $40,000 per month. Typically, the machine hours are between 4,000 and 7,000 hours per month.

Difficulty in Estimating Variable Costs

A static budget serves as a guide or map for the overall direction of the company. Better yet, when you have real-time budget visibility, you can forecast or update your budget (as needed) and see those updates reflected on other key metrics that matter to your business. Sales has a budget, marketing has a budget, product has a budget, and so on. Those siloes make flexible budgeting nearly impossible and limit the strategic value of an over-stretched finance team.

The company can then input their fixed costs, such as production materials, and determine their variable costs, which may include deliveries and other activities that are influenced by their sales. Using this budget allows the company to ensure more accuracy when determining how many sales they expect to make. The first column lists the sales and expense categories for the company. The second column lists the variable costs as a percentage or unit rate and the total fixed costs. The next three columns list different levels of output and the changes in variable costs based on the increased or decreased sales.

What Is a Fixed Cost Flexible Budget Variance?

However, it is suitable when there is a probability of fluctuations in fixed costs. It analyses the costs with respect to the variations in the output levels. Consequently, the categorization of cost takes place under Fixed, Variable and Semi-variable.

• Because of this, there are several different types of budgeting systems that can be used.
• Managers use a technique known as flexible budgeting to deal with budgetary adjustments.
• Nothing ever stays the same, and management has the responsibility to respond to unanticipated adverse conditions and to take advantage of unexpected opportunities.
• 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.
• However, it can also be too dependent on the accurate identification of both fixed and variable costs.
• However, before deciding to switch to the flexible budget, consider the following countervailing issues.
• Sales has a budget, marketing has a budget, product has a budget, and so on.

Thus, the variable portion of the cost of goods sold is 30% of revenues. Once the budget period has been completed, ABC 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.

What Is a Flexible Budget for Small Business?

The static budget is different from the flexible budget as it is a budget which stays fixed. It does not consider the possible fluctuations or changes in the costs. The amounts listed on this budget do not change, despite any other changes taking place. 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. The static budget is intended to be fixed and unchanging for the duration of the period, regardless of fluctuations that may affect outcomes.

Over time, though, your actual production, sales, and revenue will change. These changes can be due to variations such as changing inventory costs, supply chain concerns, and market conditions. You would then take your static, or master, budget and adjust the numbers based on your actual revenue. It has been “flexed,” or adjusted, based on your real production levels. Big Bad Bikes is planning to use a flexible budget when they begin making trainers. The company knows its variable costs per unit and knows it is introducing its new product to the marketplace.

What is Flexible Budgeting?

Whether switching to a flexible budgeting process from a static model or starting from scratch, there are keys to success. Unlike a static budget where you set it once and repeat the formula, a flexible budget requires constant monitoring and tweaking — with no guaranteed rewards. The hours of analysis and modifications could be rendered futile if predicted conditions, trends or objectives change. Activity-based flexible budgets are more accurate than traditional flexible budgets because they consider all factors that may affect costs.

However, it can also be too dependent on the accurate identification of both fixed and variable costs. The flexible budget will be compared to the master (static) budget to understand existing variances. A flexible budget starts with fixed expenses, then layers a flexible budgeting system on top that allows for any fluctuation in costs.

An unfavorable flexible budget then means that the costs are above the budget, which impacts the profit of the business. Let us consider the following information regarding the costs expected to be incurred by a company in the upcoming accounting period. The company wants to prepare based on a scheduled activity level of 70% of the production capacity.

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. Using the budget range for each activity driver, establish a budget model that adjusts for changes in activity levels. This model should include formulas that calculate the expected costs and revenues at different activity levels. The first step in implementing a flexible budgeting system is identifying the critical activity drivers affecting the company’s financial performance.