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. Expenditures may only vary within certain ranges of revenue or other activities; outside of those ranges, a different proportion of expenditures may apply. A sophisticated flexible budget will change the proportions for these expenditures if the measurements they are based on exceed their target ranges. Here’s a quick punch list of the pros and cons of flexible budgets.

• Though the flex budget is a good tool, it can be difficult to formulate and administer.
• To prepare a flexible budget, you need to have a master budget, really understand cost behavior, and know the actual volume of goods produced and sold.
• This type of budget would be created if management knew the future actual sales with certainty, but these are unknown and this is where a flexible budget comes in.
• Let’s imagine that a manufacturer has determined what its electricity and supplies costs are for the factory.
• Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula.
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The flexible budget example below displays both the original static budget amount as well as a flexible budget based on increased production levels. Let us see a few examples of how to calculate flexible budgets and how to perform variance analysis. The more sophisticated relative of the static budget model, a flexible budget allows for change, and as we’ve said – business can be unpredictable. 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. However, much to the disappointment of Steve and Kira, the overhead budget report reported major overruns.

Conversely, if it uses them for fewer hours, its budget should reflect that decline. Instead, Steve should flex the budget to determine how much overhead he should have, assuming that the company makes 130,000 units. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration.

Using the following information, prepare a flexible budget for the production of 80% and 100% activity. Flexible budgets are best used for startups that have a number of variables such as manufacturing, and others that have revenue based on seasonality, as costs are directly impacted by demand. After each month (or set period) closes, you compare the projected revenue against the actual revenue and adjust the next month’s expenses accordingly.

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This flexibility allows management to estimate what the budgeted numbers would look like at various levels of sales. Flexible budgets are prepared at each analysis period (usually monthly), rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level. Flexible budgets are one way companies deal with different levels of activity. A flexible budget provides budgeted data for different levels of activity. Another way of thinking of a flexible budget is a number of static budgets. For example, a restaurant may serve 100, 150, or 300 customers an evening.

• In other words, a flexible budget allows the anticipated variable costs to be adjusted according to the actual revenue level.
• Now let's illustrate the flexible budget by using different levels of volume.
• Based on this information, the flexible budget for each month would be $40,000 + $10 per MH.
• Variable costs can include marketing and sales, and may also include the cost of materials, number of sales, and shipping costs.
• Estimate the profits of the company when the factory works at 60% and 80% capacity, and offer your critical comments.

Let’s face it  – business moves fast, and we have to be flexible for what is thrown at us. Let’s suppose the production machinery had to operate for 4,500 hours during February. Let’s imagine that a manufacturer has determined what its electricity and supplies costs are for the factory.

How Does a Flexible Budget Work?

If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served? Similar scenarios exist with merchandising and manufacturing companies. To effectively evaluate the restaurant's performance in controlling costs, expensing vs capitalizing in finance business literacy institute financial intelligence management must use a budget prepared for the actual level of activity. This does not mean management ignores differences in sales level, or customers eating in a restaurant, because those differences and the management actions that caused them need to be evaluated, too.

Time Delay Issues

So if the initial static budget called for 25% to be spent on marketing, the flexible budget will maintain that same percentage for marketing whether the budget increases or decreases. Once you identify fixed and variable costs, separate them on your budget sheet. It is unlike the static or traditional budget, which cannot be changed once created.

It subsequently generates a budget that ties in specifically with the inputs. The columns would continue below with fixed and variable expenses, allowing you to see how your net profit changes based on changes in actual production and revenue. Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes.

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Flexible budgeting can be used to more easily update a budget for which revenue or other activity figures have not yet been finalized. Under this approach, managers give their approval for all fixed expenses, as well as variable expenses as a proportion of revenues or other activity measures. Then the budgeting staff completes the remainder of the budget, which flows through the formulas in the flexible budget and automatically alters expenditure levels. At its simplest, the flexible budget alters those expenses that vary directly with revenues.

Here, the figure indicates that the variable costs of producing 125,000 should total $162,500 (125,000 units x $1.30). The original budget for selling expenses included variable and fixed expenses. To determine the flexible budget amount, the two variable costs need to be updated. The new budget for sales commissions is $10,500 ($262,500 sales times 4%), and the new budget for delivery expense is $1,750 (17,500 units times 10%).

What are the advantages of flexible budgets?

Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. 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. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound.

To prepare the flexible budget, the units will change to 17,500 trucks, and the actual sales level and the selling price will remain the same. Given that the variance is unfavorable, management knows the trucks were sold at a price below the $15 budgeted selling price. What is not known from looking at it is why the variances occurred. 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.