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What is Flexible Budget? Variance, Formula and Example

Flexible Budget

If Skate increased production from 100,000 units to 125,000 units, these variable costs should also increase. Skate had a great year; actual sales came to 125,000 units. However, much to the disappointment of Steve and Kira, the overhead budget report reported major overruns.

  • Michael McFall, co-founder and co-CEO of Biggby Coffee and author of Grind, a new guide for entrepreneurs looking to build self-sustaining businesses, sees potential for too much wiggle room.
  • This flexibility to adapt to change is useful to owners and managers.
  • Some textbooks show budget reports with “F” for favorable and “U” for unfavorable after the variances to further highlight the type of variance being reported.
  • Once you have determined which costs are fixed and which are variable, separate them on your budget sheet.
  • If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH).

For each category of overhead, Steve computed a variance, identifying unfavorable variances in indirect materials, indirect labor, supervisory salaries, and utilities. This budget can be prepared even if the activity level is not decided since fixed costs are already known to every department and variable costs can be approved as a percentage of sales per unit. Variances can be calculated based on the revised budget and the actual performance. More than likely, you dutifully prepare a static budget each year and put it in your desk drawer – and it’s not seen again until it’s time to prepare a new budget.

The Advantages of a Flexible Budget

It can be seen the impact of changes in sales and production levels on revenue, expenses and ultimately income. This presentation is about flexible budgeting and how it helps in adjusting the necessary changes in volume of activity. It is opposite of static budget, which remains fixed or at one amount regardless of the volume of activity. For Skate, an analysis indicates that indirect materials, indirect labor, and utilities are variable costs. On the other hand, supervisory salaries, rent, and depreciation are fixed. Steve recomputes variable costs with the assumption that the company makes 125,000 units. 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.

Flexible Budget

The budget shown inFigure 10.27illustrates the payment of interest and contains information helpful to management when determining which items should be produced if production capacity is limited. The flexible budget can be used for the determination of budgeted sales, costs, and profits at different activity levels. In this method, the budget takes a tablet form, where horizontal columns represent the different levels of activity or capacity. And the vertical rows represent the budgeted estimates against the different levels of activity or output. The expenses are categorized into fixed, variable, and semi-variable costs. It consists of two parts – the first is the fixed cost and the fixed cost portion of the semi-variable cost. And the second is the variable cost and variable cost portion of the semi-variable cost.

Reflects changing costs

A flexible budget, on the other hand, is a series of budgets prepared for various levels of activities, revenues and expenses. Flexible budgets get modified during the year for actual sales levels, changes in cost of production and virtually any other change in business operating conditions. This flexibility to adapt to change is useful to owners and managers.

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. Spending variance is the difference between what you should have spent at your actual production level and what you did spend. If it is favorable, you spent less than your actual production level should have required. Flexible budgets are usually prepared at each business analysis period , rather than in advance.

Step 2: Identify fixed and variable costs for the period

Since these variations could have a decisive role in your company’s operational activities, you need to use a Flexible Budget, which enables you to measure these variations using variance analysis. A variance analysis simply compares planned outcomes to actual results. The next step is to combine the variable and fixed costs in order to prepare a new overhead budget report, inserting the new flexible budget results into the overhead budget report. 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. Flexible budgets are most appropriate for businesses that operate with an increased variable cost structure, where costs are primarily attached to activity levels.

  • These changes can be due to variations such as changing inventory costs, supply chain concerns, and market conditions.
  • It is quite difficult to prepare and requires experts for its preparation.
  • The procedure for drawing up a flexible budget is quite straight forward.
  • However, there are also a number of serious issues with it, which we address below.
  • Changing costs in the manufacturing process can severely impact your profit margin.

A flexible budget cannot be preloaded into the accounting software for comparison to the financial statements. 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 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.

What Is a Flexible Budget for Small Business?

If a manager is only responsible for a department’s costs, to include all the manufacturing costs or net income for the company would not result in a fair evaluation of the manager’s performance. If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance. To prepare a flexible budget, the business owner or manager must clearly categorize expenses into fixed, variable and semi-variable expenses. Objective and clear categorization of these costs can be tricky and thus can jeopardize the entire budgeting process. Business owners and their staff must have the expertise and knowledge to prepare a flexible budget accurately, comprehend it and use it appropriately. If such expertise and understanding is missing, a flexible budget is definitely not an answer.

What are the features of flexible budget?

  • The flexible budget covers a range of activities,
  • A flexible budget is easy to change according to variations of production and sales levels.
  • Flexible budget facilitates performance measurement and evaluation.
  • It takes into account the changes in the volume of activity.

Revenue is still calculated at month end so costs cannot be retroactively adjusted. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound. Enter the resulting flexible budget for the completed period into the accounting system for comparison to actual expenses.

Flexible budgets create an accurate picture of production costs

Consequently, a more sophisticated format will also incorporate changes to many additional expenses when certain larger revenue changes occur, thereby accounting for step costs. By incorporating these changes into the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity.

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