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Creating a flexible budget Accounting and Accountability

flexible budget example

A flexible budget is best used in a manufacturing environment where the budget is able to be based on production volume. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound. Revenue variance is the difference between what revenue should have been for the actual production activity and what the actual revenue you take in is. It may be favorable (higher than it should have been for actual production activity) or unfavorable (lower than it should have been).

  • It has been “flexed,” or adjusted, based on your real production levels.
  • The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance.
  • A sophisticated flexible budget will change the proportions for these expenditures if the measurements they are based on exceed their target ranges.
  • If the machine hours in February are 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH).
  • A master budget is static, accounting for one level of production volume.
  • However, it is suitable when there is a probability of fluctuations in fixed costs.

Using a flexible budget allows you to account for increased revenues, higher labor costs, and higher inventory costs during the busier months without having to adjust for months when business is slower. With a flexible budget, it’s easy to show that while costs for a month might have been much higher than budgeted, so were sales – justifying the increase. You can also study the monthly adjustments and notes to more accurately plan for future costs. Revenue and cost needs to be compared monthly and adjustments or notes should be made. Additionally, flexible budgets have a lack of accountability to some degree since they are so fluid and open to change. 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.

Benefits of having a flexible budget for your small business

This comparison allows you to make any future adjustments based on the flexible budget variance indicated in the comparison. Creating a flexible budget begins with assigning all static costs a fixed monthly value, and then determining flexible budget example the percentage of revenue to assign to your variable costs. A flexible budget often uses a percentage of your projected revenue to account for variable costs rather than assigning a hard numerical value to everything.

In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget. But two months into the fiscal year, a competitor closes its doors. Suddenly, there is only one company to meet demand for widgets, resulting in actual sales of 200 units per month. The actual revenue the widget company is taking in has doubled—but the production costs would also go up.

Step 3: Enter production levels based on actuals

This represents your best guess at what will be spent and what will be earned. A flexible budget is a budget that changes based on your actual production or revenue. Unlike a static budget, it adjusts your original budget projection in using your actual sales or revenue. Let us consider the https://www.bookstime.com/articles/accounting-florida following information regarding the costs expected to be incurred by a company in the upcoming accounting period. The company wants to prepare based on a scheduled activity level of 70% of the production capacity. The number of units that can be designed at this production capacity is 7000.

flexible budget example

Its production equipment operates, on average, between 3,500 and 6,500 hours per month. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. The accuracy of the budget largely depends upon the efficient classification of the costs.

What is the starting point in the master budget process?

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. 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.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration. Flexible budgets work by taking the pressure off to predict future happenings. More often than not, our budgets should be just as flexible as we are.

Pros and Cons of Flexible Budgeting

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%). These are added to the fixed costs of $12,500 to get the flexible budget amount of $24,750. Since the flexible budget restructures itself based on activity levels, it is a good tool for evaluating the performance of managers – the budget should closely align to expectations at any number of activity levels. It is also a useful planning tool for managers, who can use it to model the likely financial results at a variety of different activity levels. In its simplest form, the flex budget uses percentages of revenue for certain expenses, rather than the usual fixed numbers.

flexible budget example

A flexible budget is an estimate of revenues and expenses prepared for a budgeted activity level and allowed to vary as the activity level changes in the actual results. This flexible budget is unchanged from the original (static budget) because it consists only of fixed costs which, by definition, do not change if the activity level changes. 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. However, if actual performance in a given month or quarter is different from the planned amount, it is difficult to determine whether costs were controlled. Lobster Instant Noodles make instant ramen noodles in cups that are commonly eaten by university students across the world. Simply add boiling water, close the lid for 3 minutes and you’ve got an instant meal.

How to Create A Flexible Budget?

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. Thereafter, prepare a flexible budget for single or multiple activity levels. Changing costs in the manufacturing process can severely impact your profit margin. Any unexpected market shifts may find a material essential to your production line suddenly costing more than three times the original budgeted amount.

  • Revenue is still calculated at month end so costs cannot be retroactively adjusted.
  • The flexible budget adjusts accordingly based on the actual activity level.
  • He is the sole author of all the materials on AccountingCoach.com.
  • In publicly-traded companies, often a combination of both approaches is used.
  • Imagine your product goes viral on social media and gains unexpected popularity overnight, now there is a demand for 20 units next month, which would cost $20 to make.
  • The budget committee usually develops the master budget for each year, guided by the budget director, who is usually the controller of the company.
  • Both manufacturing and non-manufacturing companies can benefit from a master budget.

This helps in a transparent and accurate calculation of variances. 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. A flexible budget is kind of a hybrid approach to financial planning. It begins with a static framework built from the costs that are not anticipated to change throughout the year. Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance.

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