For example, consider a web store that downloads software to its customers; a certain amount of expenditure is required to maintain the store, and there is essentially no cost of goods sold, other than credit card fees. In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget. 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.
- This ability to change the budget also makes it easier to pinpoint who is responsible if a revenue or cost target is missed.
- Flexible budgets are especially helpful in environments where costs are closely aligned with the level of business activity.
- For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier.
- Given that the variance is unfavorable, management knows the trucks were sold at a price below the $15 budgeted selling price.
- The lack of a variance indicates that costs in total (materials, labor, and overhead) were the same as planned.
Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. Static budgets may be more effective for organizations that have highly predictable sales and costs, and for shorter-term periods. This is the simplest and most common budget for small businesses or for quick, high-level analysis. It typically adjusts the budgeted figures for one or a few key variables, such as sales volume or production levels. In summary, a flexible budget takes more time to create, delays the release of financial statements, does not account for income variances, and may not be suitable in some budget models.
Intermediate Budget Flexibility
However, a flexible budget allows managers to assign a percentage of sales in calculating the sales commissions. The management might assign a 7% commission for the total sales volume generated. Although with the flexible budget, costs would rise as sales commissions increased, so too would revenue from the additional sales generated. A flexible budget is an adjustable budget that companies create for different levels of activity, i.e., different output levels, revenues, or expenses for a single budgeting period.
You should assume that the fixed expenses remain constant for all levels of production. Using the following information, prepare a flexible budget for the production of 80% and 100% activity. A company’s input pricing and raw materials may fluctuate as a result of a sudden rise in demand or a supply constraint. Furthermore, as labor laws and minimum wage requirements change, the cost of labor rises.
4 Flexible Budgets
For example, Figure 10.26 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes. However, it is suitable when there is a probability of fluctuations in fixed costs. It analyses the costs with respect to the variations in the output levels.
What is a flexible budget?
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. A great deal of time can be spent developing step costs, which is more time than the typical accounting staff has available, especially when in the midst of creating the more traditional static budget. 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. 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.
A flexible budget lets you adjust to global trends and economic changes rather than trying to anticipate when those will happen (and likewise brace for their impact). A flexible budget is one that takes into account your actual production and revenue rather than what you originally projected. This represents your best guess at what will be spent and what will be earned. 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. In short, the flexible budget is a more useful tool when measuring a manager’s efficiency.
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If it is favorable, you spent less than your actual production level should have required. Learn how it can help your business respond to the ups and downs of the marketplace. These points make the flexible budget an appealing model for the advanced budget user. However, before deciding to switch to the flexible budget, consider the following countervailing issues. They allow managers to predict the effect that changes will have on their company’s income statement and balance sheet while still being able to reflect actual figures.
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, 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. Some businesses have so few variable costs of any kind that creating a flexible budget is pointless. Instead, they have a tremendous fixed overhead that does not change in response to any form of activity.
The budget shown in Figure 7.25 illustrates the payment of interest and contains information helpful to management when determining which items should be produced if production capacity is limited. If, however, the cost was identified small business banking 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.
Consider a web store that provides software downloads to its clients; a certain amount of investment is required to run the business, but there is basically no cost of goods sold, other than credit card costs. In this case, creating a flexible budget is pointless because it will not differ from a static budget. 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 the fixed costs and the variable costs. Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases.