What Are Flexible Budgets? 4 Best Practices

Additionally, flexible budgets have a lack of accountability to some degree since they are so fluid and open to change. While flexible budgets are often used for manufacturing overhead, they’re also pretty common for SaaS businesses. If a SaaS company is forecasting its cost of benefits, it might tie the budget line item to its headcount forecast. So as headcount increases, the cost of benefits also increases according to the per-employee assumption.

• Let’s imagine that a manufacturer has determined what its electricity and supplies costs are for the factory.
• It provides insights into how well an organization has managed its finances in response to changing conditions and activity levels.
• In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity.
• The first column lists the sales and expense categories for the company.
• A static budget is a type of budget that incorporates anticipated values about inputs and outputs that are conceived before the period in question begins.

Expenses such as rent, management salaries, and marketing costs remain static and do not change based on production. For example, Figure 7.24 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes. In conclusion, the budget that companies can prepare for multiple output levels is a Flexible Budget. Practically, managers widely use this type of budget as it is the most realistic one.

Difference Between Fixed and Flexible Budgets

In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget. ABC Company has a budget of $10 million in revenues and a $4 million cost of goods sold. Of the $4 million in budgeted cost of goods sold, $1 million is fixed, and $3 million varies directly with revenue.

When using a static budget, some managers use it as a target for expenses, costs, and revenue while others use a static budget to forecast the company’s numbers. Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. 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. Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information.

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At 80% capacity, the working raw materials cost increases by 5% and selling price falls by 5%. At 50% capacity, the cost of working raw materials increases by 2% and the selling price falls by 2%. Semi-variable expenses remain constant between 45% and 65% capacity, increasing by 10% between 65% and 80% capacity, and by 20% between 80% and 100% capacity. 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.

Revenue Comparison

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. For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier. In a static budget situation, this would result in large variances in many accounts due to the static budget being set based on sales that included the potential large client.

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. Flexible budgeting puts more pressure on you to have rock-solid financial assumptions as you tie various line items together in the model. And the reality is that the effort you put into tying certain line items together may not be worth the time. Not every line item or set of line items has a strong enough correlation to others for flexible budgeting to work. Choosing the wrong pieces of the budget to tie together can lead to significant inaccuracies in forecasts. Flexible budgeting is a dynamic budgeting model that allows you to adjust to changes in costs and revenue in real time.

Subsequently, the budget varies, depending on activity levels that the company experiences. If such predictive planning is not possible, there will be a disparity how to calculate the present value of an annuity due between the static budget and actual results. In contrast, a flexible budget might base its marketing expenses on a percentage of overall sales for the period.

Flexible Budget Meaning

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. With flexible budgets, it’s easy to make updates to revenue and activity figures that haven’t been finalized. Because of these seamless workflows (and because of the inherent adaptability), flexible budgets give way to more efficiency than their fixed budget counterparts. Most flexible budgets use a percentage of projected revenue to account for variable costs rather than assigning a rigid numerical value at the start.

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. The next three columns list different levels of output and the changes in variable costs based on the increased or decreased sales. The original budget for selling expenses included variable and fixed expenses. To determine the flexible budget amount, the two variable costs need to be updated.

This adaptability allows flexible budgets to offer a precise picture of company performance, seeing as they’re always working with the most current data and details. Instead of estimating production levels, use the actuals from the previous month to create your flexible budget. For instance, if your company produced 50,000 units in January, and you want to budget for 75,000 units in February, you have to look at your variable costs.

For example, if your business predicts that five units will sell per month at $5 each, you can expect a revenue of $25 a month. And with out-of-the-box metrics, templates, and dashboards like the forecast vs. actuals dashboard, you can shorten the budget allocation and planning process from two weeks down to two days. Following are some of the advantages and problems of a flexible budget. At first, you need to analyze the range under which the activity is expected to fluctuate. 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.