A flexible budget is best used in a manufacturing environment where the budget is able to be based on production volume. 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. Flexible budgets do not fix variances, they help to better plan for the future. Revenue is still calculated at month end so costs cannot be retroactively adjusted.

• 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.
• They take into account that a business is an organic, growing system and that life is not predictable.
• This is the simplest and most common budget for small businesses or for quick, high-level analysis.
• Its production equipment operates, on average, between 3,500 and 6,500 hours per month.

Steve recomputes variable costs with the assumption that the company makes 125,000 units. For example, your master budget may have assumed that you’d produce 5,000 units; however, you actually produce 5,100 units. The flexible budget rearranges the master budget to reflect this new number, making all the appropriate adjustments to sales and expenses based on the unexpected change in volume. Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter.

What Are Flexible Budgets? 4 Best Practices

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.

• Historically financial modeling has been hard, complicated, and inaccurate.
• The model is designed to match actual expenses to expected expenses, not to compare revenue levels.
• Following are some of the advantages and problems of a flexible budget.
• A flexible budget provides budgeted data for different levels of activity.
• In addition, a flexible budget can successfully justify increases in costs when compared to actual income.

Estimate the profits of the company when the factory works at 60% and 80% capacity, and offer your critical comments. These points make the flexible budget an appealing model for the advanced budget user. However, before deciding to switch to the flexible budget, consider the following countervailing issues. Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula. If you don’t want to spend hours tracking and forecasting your budget in spreadsheets, check out our financial modeling tool. Finmark is everything you need to build an accurate, customized financial model.

Subsequently, the budget varies, depending on activity levels that the company experiences. In theory, a flexible budget is not difficult to develop since the variable costs change with production and the fixed costs remain the same. However, planning to meet an organization’s goals can be very difficult if there are not many variable costs, if the cash inflows are relatively fixed, and if the fixed costs are high.

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A flexible budget is one that takes into account your actual production and revenue rather than what you originally projected. This represents your best guess at what will be spent and what will be earned. 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.

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

Then, they can modify the flexible budget when they have their actual production volume and compare it to the flexible budget for the same production volume. A flexible budget is more complicated, requires a solid understanding of a company’s fixed and variable expenses, and allows for greater control over changes that occur throughout the year. For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier. In a static budget situation, this would result in large variances in many accounts due to the static budget being set based on sales that included the potential large client. A flexible budget on the other hand would allow management to adjust their expectations in the budget for both changes in costs and revenue that would occur from the loss of the potential client. The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance.

These are added to the fixed costs of $12,500 to get the flexible budget amount of $24,750. The flexible budget uses the same selling price and cost assumptions as the original budget. The variable amounts are recalculated using the actual level of activity, which in the case of the income statement is sales units. While variances are noted in static budgets, a flexible budget allows you to enter the revenues and expenses relevant to that particular budget period, adapting flexible costs using real-time data.

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It accurately represents expected financial outcomes in the real world by considering different scenarios and variations in income and expenses. To effectively manage a company, top managers must quickly find out the reasons for the deviation of the company’s financial and economic indicators from understanding the balance sheet the planned ones established in the financial budgets. However, many of these indicators are directly interrelated and not static. For example, the volume of the company’s activities (planned revenue) may change significantly under the influence of not always predictable external factors.

If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance. Keep in mind that if you or your bookkeeper are unfamiliar with cost accounting, the process of creating a flexible budget is best left in the hands of an accounting professional or CPA. Expenses such as rent, management salaries, and marketing costs remain static and do not change based on production.

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The flexible budget will show different possibilities for variable expenses and revenue. Variable costs can include marketing and sales, and may also include the cost of materials, number of sales, and shipping costs. For example, if your production of widgets is 100 per month, your variable admin costs may be $200 per month. However, if your production of widgets is 200 per month, your variable admin costs would increase to $400. A flexible budget is a budget that changes based on your actual production or revenue.

Benefits of having a flexible budget for your small business

This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue. With a flexible budget model, if your demand suddenly triples, your cost of goods sold (COGS) can be adjusted by a predetermined percentage ensuring that you have the cash to fill these orders. 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.

Companies develop a budget based on their expectations for their most likely level of sales and expenses. Often, a company can expect that their production and sales volume will vary from budget period to budget period. They can use their various expected levels of production to create a flexible budget that includes these different levels of production.