These changes can be due to variations such as changing inventory costs, supply chain concerns, and market conditions. You would then take your static, or master, budget and adjust the numbers based on your actual revenue. It has been “flexed,” or adjusted, based on your real production levels. Flexible budgets are especially helpful in environments where costs are closely aligned with the level of business activity.
Flexible budgets have a reputation for being more time-consuming than other budgeting models. That’s because flexible budgets require continual upkeep and maintenance — you’re constantly having to keep an eye out for fluctuations and then execute those changes as quickly as you can. While this isn’t a reason to avoid flexible budgeting altogether, it’s good to keep in mind as you consider how and when to implement this kind of budgeting strategy. If your company regularly conducts a flux analysis, syncing this process with your flexible budget creation can help save time.
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Actual results are compared to the static budget numbers as one means to evaluate company performance. However, this comparison may be like comparing apples to oranges because variable costs should follow production, which should follow sales. Thus, if sales differ from what is budgeted, then comparing actual costs to budgeted costs may not provide a clear indicator of how well the company is meeting its targets. A flexible budget created each period allows for a comparison of apples to apples because it will calculate budgeted costs based on the actual sales activity. A static budget is one that is prepared based on a single level of output for a given period.
The ability to focus spending on what is most important you or your family makes this method appealing; however, it requires discipline and clarity regarding financial goals to be effective. This strategy is most effective if you have a stable income and control over your spending, as it requires a sufficient financial cushion to accommodate upfront savings. However, the rigidity and the intensive planning this method requires can be daunting for those with fluctuating incomes.
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Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula. Ever wonder how your barber gets such a close shave when he’s doing skin fades or cleaning up your neck? Enter this foil shaver, which is hard what is a flexible budget to beat when it comes to closeness. Speaking of which, Alexander gives the Andis tool his stamp of approval because it works efficiently for shaving experiences at home and in the barbershop. Adopting a proactive approach to budgeting is crucial for achieving financial well-being.
However, this approach ignores changes to other costs that do not change in accordance with small revenue variations. Consequently, a more sophisticated format will also incorporate changes to many additional expenses when certain larger revenue changes occur, thereby accounting for step costs. By incorporating these changes into the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity. In theory, a flexible budget is not difficult to develop since the variable costs change with production and the fixed costs remain the same.
Why do companies use flexible budgets?
Instead, the hope is that patterns will be observed making future cost planning easier and more accurate. In addition, a flexible budget can successfully justify increases in costs when compared to actual income. 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.
Let’s assume a company determines that its cost of electricity and supplies will vary by approximately $10 for each machine hour (MH) used. It also knows that other costs are fixed costs of approximately $40,000 per month. Typically, the machine hours are between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. Better yet, when you have real-time budget visibility, you can forecast or update your budget (as needed) and see those updates reflected on other key metrics that matter to your business.
