How to Implement a Flexible Budget

Using a flexible budget will immediately alert you to any changes that are likely to impact your bottom line, allowing you to make changes proactively instead of reactively. Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. A factory is currently working at 50% capacity and produces 10,000 units.

  • Suddenly, there is only one company to meet demand for widgets, resulting in actual sales of 200 units per month.
  • However, this approach ignores changes to other costs that do not change in accordance with small revenue variations.
  • A company makes a budget for the smallest time period possible so that management can find and adjust problems to minimize their impact on the business.
  • Flexible budgets work by taking the pressure off to predict future happenings.
  • The master budget, and all the budgets included in the master budget, are examples of static budgets.

The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250. Actual expenses are lower because the income before income taxes was lower. Although the budget report shows variances, it does not explain the reasons for the variance. The budget report is used by management to identify the sales or expenses whose amounts are not what were expected so management can find out why the variances occurred.

Big Bad Bikes developed a flexible budget that shows the change in income and expenses as the number of units changes. It also looked at the effect a change in price would have if the number of units remained the same. The expenses that do not change are the fixed expenses, as shown in Figure 7.23. A flexible budget flexes the static budget for each anticipated level of production.

What is a Flexible Budget?

By understanding the variances, management can decide whether any action is needed. Favorable variances are usually positive amounts, and unfavorable variances are usually negative amounts. Some textbooks show budget reports with “F” for favorable and “U” for unfavorable freelance invoice template after the variances to further highlight the type of variance being reported. While accounting software is an important part of tracking all of your financial transactions, many software applications simply don’t have the capability of preparing a flexible budget.

  • Using the following information, prepare a flexible budget for the production of 80% and 100% activity.
  • Any unexpected market shifts may find a material essential to your production line suddenly costing more than three times the original budgeted amount.
  • Over time, though, your actual production, sales, and revenue will change.
  • Fixed expenses such as rent, utilities, equipment costs, and salaries usually make up a significant portion of any business budget.
  • For example, a restaurant may serve 100, 150, or 300 customers an evening.

For example, this article shows some large U.S. cities are faced with complicated budgets because of high fixed costs. In an unpredictable financial world, flexible budgets are helpful in manufacturing industries where costs change with a change in activity level. Companies must involve experts to make accurate budgets, ensuring there is less scope for error and improving variance analysis. In its simplest form, the flex budget uses percentages of revenue for certain expenses, rather than the usual fixed numbers. This allows for an infinite series of changes in budgeted expenses that are directly tied to actual revenue incurred.

When to Use Forecasting Instead of a Budget

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. In the original budget, making 100,000 units resulted in total variable costs of $130,000. Dividing total cost of each category by the budgeted production level results in variable cost per unit of $0.50 for indirect materials, $0.40 for indirect labor, and $0.40 for utilities. The original budget assumed 17,000 Pickup Trucks would be sold at $15 each.

Best Practices of Flexible Budgeters

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Terms Similar to Flexible Budget

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. Accountants enter actual activity measures into the flexible budget at the end of the accounting period.

Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed for future periods. The company also knows that the depreciation, supervision, and other fixed costs come to about $35,000 per month. 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). For example, a widget company might start out the year with a static planning budget that assumes that the cost to produce 10 widgets is $100, and the company will produce 100 units per month.

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. This allows for budget adjustments to occur in real-time, taking into account external factors. 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.

In other words, a flexible budget allows the anticipated variable costs to be adjusted according to the actual revenue level. Big Bad Bikes is planning to use a flexible budget when they begin making trainers. The company knows its variable costs per unit and knows it is introducing its new product to the marketplace. Its estimations of sales and sales price will likely change as the product takes hold and customers purchase it.

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. Now, let’s assume that it costs one dollar to make each unit of product, so you budget $5 a month for this. 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. If the factory has to use more machine hours one month, its budget should logically increase.

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Learn how it can help your business respond to the ups and downs of the marketplace. In other words, comparing the $60,000 actual cost of making 125,000 units to the $50,000 budgeted cost of making just 100,000 units makes no sense. For example, Figure 7.24 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes.

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