Flexible Budgets

Flexible Budget

Flexible Budgeting Defined

Flexible budgeting can make organizations' budgets dynamic and up-to-date.

A flexible budget computes budgeted costs and revenues by analyzing the actual level of output in the same budget period. The flexible budget is calculated based on actual production, in contrast to the static budget, which is based on projections and does not change even if a significant event happens during production. Because it is difficult to create a perfect forecast, it is common for variations to happen. Understanding variances and narrowing down cost drivers can be difficult and time-consuming, which is where the flexible budget becomes useful.

The flexible budget helps companies learn why a static budget was inaccurate. This form of budgeting is essentially the corrected budget that assumes a company perfectly projected its output. The flexible budget assumes that all of the costs in relation to producing the unit, both variable and fixed, remain the same with the number of units produced.

Unlike static budgets, flexible budgets manage multiple levels of activity. Therefore, it is much more common for larger companies with sizeable activity to use a flexible budget. A static budget is better suited for a smaller company with a simpler operation. However, every company, no matter how big or how small, should evaluate its needs when determining whether it would benefit from a flexible or static budget. Each company has its own considerations that may make one budget form more advantageous than the other.

Static Budget versus Flexible Budget

Static Budget Flexible Budget
Effective Time Prepared to begin at the beginning of the budget period Prepared to begin at any time during the budget period
Levels of Activity Handles one level of activity Handles multiple levels of activity
Changes during Budget Period Does not change during the budget period Can change multiple times throughout the budget period
Variable Costs Remains the same Allows for flexibility
Variance Types Can be favorable or unfavorable Can be favorable or unfavorable

Static budgets and flexible budgets each have their own advantages and disadvantages. Companies often use both budgets to determine any variances and reduce costs.

Flexible Budgeting Process

Flexible budgeting requires periodic adjustments to the budget.

The flexible budgeting process usually has four steps.

1. The company needs to identify the number of units actually sold. This means the company needs to narrow its scope. The company's identification of units actually sold must reflect only the product being examined and sales that were completed during the relevant budget period. Considering different products, incomplete sales, and the wrong time periods will result in an inaccurate flexible budget.

2. The company calculates its flexible budget for its revenues. The company computes the equation for flexible-budget revenues by multiplying the budgeted sales price per unit by the number of units sold.

3. The company calculates its flexible budget for total costs. The equation for flexible-budget costs is flexible-budget variable costs added to the flexible-budget fixed costs. This would be an appropriate time for the company to reevaluate its costs to make sure that they are properly categorized as either fixed or variable. As its name suggests, flexible budgeting requires periodic adjustments to the budget, which should happen at this step while the company is considering how its costs are changing with different activity levels.

4. The company should compare its calculated flexible budget to actual costs with a flexible budget variance. A flexible budget variance is the difference between the calculations from the flexible budget analysis and the company's actual results for the budget period. This comparison gives companies valuable insight on how to adjust their budgets to be more accurate for upcoming periods. However, this is not as easy as it sounds. External factors, such as seasonality, may affect the budget. For example, in the case of a company that makes bed linens, perhaps customers buy more sheets and blankets in the fall and winter than in the spring and summer.

These steps provide a company with a comprehensive analysis of any favorable or unfavorable static budget that is affecting the company's operating income.

Flexible Budgeting

A flexible budget provides helpful information for companies to reduce their overall costs and increase profitability. However, there can be external factors affecting the budget that must also be considered.