A Small Business Guide To Flexible Budgets

a small business guide to flexible budgets

The original budget assumed 17,000 Pickup Trucks would be sold at $15 each. 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. They work well for evaluating performance when the planned level of activity is the same as the actual level of activity, or when the budget report is prepared for fixed costs.

By knowing where the company is falling short or exceeding the mark, managers can evaluate the company’s performance more efficiently and use the findings to make any necessary changes. Cost accounting is a form of managerial accounting that aims to capture a company’s total cost of production by assessing its variable and fixed costs. The first step in creating a flexible budget is to create a static overhead budget. This allows you to assume standard production levels and all associated expenses. The static budget also serves as a base for adjusting budget variances on the flexible budget. 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.

1 Flexible Budgets

Also, companies can ask for more flexible options for their accounts payables, which is money owed to suppliers to help with any short-term cash-flow needs. A cash-flow budget helps managers determine the amount of cash being generated by a company during a period.

What is the key difference between a static budget and a flexible budget PDF?

Static Budget vs Flexible Budget

A static budget once formulated cannot be changed irrespective of changes occurring in its assumed activity before the fixed period is over. A flexible budget however is free to be adapted according to changes at any point of the set period.

As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company’s operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University. With flexible budgets, managers are constantly updating their projections and cost controls with current information. The most significant advantage of flexible budgets over static ones is the ability to adapt to changes in the real world. Nothing ever stays the same, and management has the responsibility to respond to unanticipated adverse conditions and to take advantage of unexpected opportunities.

Fixed costs do not change each month, i.e., they remain the same. The company also knows that the depreciation, supervision, and other fixed costs come to about $35,000 per month. If the financial needs of a factory, for example, change regularly, a flexible budget makes more sense. A static budget stays at a single amount regardless of how much activity there is. Total net income changes as the amount for each line on the income statement changes. The net variance in this example is mainly due to lower revenues.

Flexible Budgets

The flexible budget might show that the company paid employees $15,000 in wages instead of $13,000, reflecting extra hours that they worked. By comparing short-term budgets each day or week over time, a manager can track factors that make a difference in the company’s success.

It can be seen the impact of changes in sales and production levels on revenue, expenses and ultimately income. This flexible budget is unchanged from the original because it consists only of fixed costs which, by definition, do not change if the activity level changes. A flexible budget is the kind of budget that prepared in a way that allows it to changes according to changes in the assumptions made during its preparation. One has to have intricate knowledge of which costs are fixed and which are not and prior knowledge of the effect of changes of assumptions.

Suppose the budget was set up with the expectation that sales would be $200,000 per month and labor cost was budgeted at $50,000 per month, or 25 percent of sales. Similarly, while a static budget would limit hiring more employees, a flexible budget would adapt to the need for more staff to meet increased demand by increasing the budget for payroll expenses. Variable expenses in flexible budgets are defined as percentages of sales.

Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. Revenues and expenses are constantly adjusted in flexible budgets for current operating conditions. New environmental regulations might increase the costs of production and could require the purchase of different types of machines. Weather conditions could increase shipping costs and result in delayed shipments to customers. With static budgets, costs of operations and product profit margins are set at the start of the year, based on historical data. Flexible budgets also allow companies to model how they might allocate their funds in lieu of particular changes. A company can prepare an array of flexible budgets that each reflect a different scenario.

a small business guide to flexible budgets

They are useful to encourage your procurement staff to obtain the goods and services you need at the lowest possible price. It can also be calculated as per-unit variable cost over the per-unit sales cost, or $.75 / $3. For sake of illustration, let’s use a very simple, three-month budget for a coffee shop as an example. Over this time period, the shop expects an average of 250 customers per day , each buying one cup of coffee that costs $3. Expense Type Description Examples Fixed Costs that do not change over the short-term, even if there is a shift in the amount of goods/services produced or sold.

Step 3: Enter Production Levels Based On Actuals

We’ve learned from on-the-ground experience about these terms specially the product comparisons. It may be tricky to analyze the variances of cost, as the nature of all the expenses may not be the same. Prediction can be highly volatile as it depends upon factors of production which are beyond managerial controls.

  • When the calculation is based on units sold, however, it may reveal differences in revenue and expenses per unit.
  • The management might assign a 7% commission for the total sales volume generated.
  • The result is that a flexible budget yields a budgeted cost of goods sold of $3.7 million at a $9 million revenue level, rather than the $4 million that would be listed in a static budget.
  • Businesses are finding that to be true when it comes to budgeting.

It helps to set the prices and quotations for a business contract. Fixed cost, for example, rent, insurance premium, etc. remains the same every month, irrespective of the actual machine hour used. 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.

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The price per unit increased to $200 due to an increase in the cost of a material used to create the product. This tells us that there is a negative what is a flexible budget variance due to uncontrollable variable costs. If, however, the flexible budget variance was unfavorable, it would be the result of prices or costs.

a small business guide to flexible budgets

A flexible budget is a kind of budget that can easily change input variables over time. It forecast revenues and expenses with a variety of activity levels. Unlike a static budget, it can include any activity level from the business. The cost of production can be divided into fixed and variable costs so flexible budgeting typically associates variable costs with changing activity levels. Flexible budgets are one way companies deal with different levels of activity. A flexible budget provides budgeted data for different levels of activity.

Operating Budget

The idea behind the alternatives is that by planning for potential changes in production costs or sales volume, the business can respond quickly and keep the company profitable. Sometimes referred to as a variable or dynamic budget, households and non-profit organizations can also make use of this particular approach to budgeting. The flexible budget variance compares the flexible budget to actual results to determine the effects that prices or costs have had on operations. By comparison, the sales-volume variance compares the flexible budget to the static budget to determine the effect that a company’s level of sales activity had on its operations.

What is flexible budget example?

This type of budget is most often based on changes in a company’s actual revenue and uses percentages of revenue rather than static numbers. For example, a flexible budget may allot 25% of a company’s revenue to salary as opposed to allotting $100,000 to salary in a given year.

Subsequently, the budget varies, depending on activity levels that the company experiences. For costs that vary with volume or activity, the flexible budget will flex because the budget will include a variable rate per unit of activity instead of one fixed total amount.

Such budgets also rely on the assumption of continuity when costs may actually behave in a stepped or discontinues manner. Flexible budgets enable more accurate assessment of managerial and organizational perfor­mance.

Accounting Topics

For example, if sales were to increase dramatically, flexible budgets would get adjusted to increase spending on marketing to take even more advantage of unexpected increases in revenues. It’s a budget that is prepared at the beginning of the year and not changed until it’s time to make a new one at the start of the next year. The numbers do not change for the entire year, regardless of anything that happens in the business environment. Although flexed budgets tend to maintain fixed costs at the same level whatever the level of output/sales, very often fixed costs are actually fixed only over a relevant output range. Build up the appropriate flexible budget for specified levels of activity. For example, a hotel might create a budget showing what its profits and expenses would be if it had 10,800 bookings that year. The hotel might also create a budget showing profits and expenses for booking 8,000 rooms and 5,000 rooms that year.

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The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250. Actual expenses are lower because the income before income taxes was lower.

If the company had planned to spend $8,300 on equipment but actually spent $10,200 because of breakdowns, the flex budget would show the latter. Companies prepare flexible budgets at the end of an accounting period to compare how they actually spent their money with how they had planned to spend their money. The original budgets, the static budgets, show how they had expected to spend their funds.

A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses. In order to accurately predict the changes in costs, management has to identify thefixed costsand thevariable costs. Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases. Consequently, the flex budget tends to include only a small number of step costs, as well as variable costs whose fixed cost components are not fully recognized. If, however, the cost was identified as a fixed cost, no changes are made in the budgeted amount when the flexible budget is prepared. Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range.

However, its income was found to be only $ 16 million at the end of the year. The difference between the two values is termed a static variance.