Cost Ascertainment is also not possible in case of fixed budget if the actual and budgeted levels of activity vary and the same can be easily determined in the case of a https://personal-accounting.org/flexible-budget-definition/. If such predictive planning is not possible, there will be a disparity 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.
- A flexible budget is a budget that changes based on your actual production or revenue.
- For example, finance can build a percentage into the basic flexible model, which they multiply by actual revenues to determine the expenses at a specified revenue level.
- The actual revenue the widget company is taking in has doubled—but the production costs would also go up.
Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range. 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. In a flexible budget, there is no comparison of budgeted to actual revenues, since the two numbers are the same. The model is designed to match actual expenses to expected expenses, not to compare revenue levels.
Everything starts with the estimated sales, but what happens if the sales are more or less than expected? What adjustments does a company have to make in order to compare the actual numbers to budgeted numbers when evaluating results? If production is higher than planned and has been increased to meet the increased sales, expenses will be over budget. To account for actual sales and expenses differing from budgeted sales and expenses, companies will often create flexible budgets to allow budgets to fluctuate with future demand. Flexible budgets are one way companies deal with different levels of activity.
Static vs. Flexible Budgeting
A flexible budget is a redrafted budget prepared in accordance with different activity levelsor at different capacity utilization levels which changes with eachchange in change activity levels of the organisation. Here, actual revenues and other cost details are placed during or after the completion of a financial period.Flexible budget is prepared from fixed budget and is therefore known as revised budget. Once after preparation of flexible budget, management compare actual figures and determine variances. Performing this activity helps management to analyse reasons for deviations at an early stage and take suitable corrective actions at the earliest.
There is no way to highlight whether actual revenues are above or below expectations. Flexible budgeting can be used to more easily update a budget for which revenue or other activity figures have not yet been finalized. Under this approach, managers give their approval for all fixed expenses, as well as variable expenses as a proportion of revenues or other activity measures. Then the budgeting staff completes the remainder of the budget, which flows through the formulas in the flexible budget and automatically alters expenditure levels. Flexible means easily adjustable, and Budget refers to an anticipated plan made for the financial activities of the entity. Therefore, the flexible budget is a financial plan created for different activity levels.
However, when compared to the actual results that are received after the fact, the numbers from static budgets can be quite different from the actual results. Static budgets are used by accountants, finance professionals, and the management teams of companies looking to gauge the financial performance of a company over time. This budgeting method is totally different from a fixed budget as here the budgeted costs are varying with the actual input and output levels of the business. It is more important for any organization to analyse the variances identified by flexible budgets due to the fact that flexible budget determines the standard cost of operating for actual output levels. A static budget is typically based on a fixed level of activity or output and does not change with changes in sales volume, production volume, or other measures of business activity.
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.
Key Differences Between Fixed Budget and Flexible Budget
Once you identify fixed and variable costs, separate them on your budget sheet. Thereafter, prepare a flexible budget for single or multiple activity levels. For Example, A company has prepared a flexible budget and expects an output of 500 units. By understanding the advantages and disadvantages of a flexible budget, businesses can make an informed decision about which budgeting approach is best for their needs. As you can see, the flexible budget adjusts the expected food expenses based on a higher cost per customer, resulting in an extra $1,500 in the overall budget. Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance.
Need for a Flexible Budget
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.
Basic Flexible Budget
If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance. Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes. 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.
Differences between Flexible Budget and Static Budget
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 adjusts based on changes in actual revenue or other activities. The result is a budget that is fairly closely aligned with actual results.
There were also fixed costs of $25,000 related to the factory and $25,000 related to selling and administration. A flexible budget is a budget that adjusts for changes in the level of activity or output. Unlike a static budget, which is based on a fixed level of activity or output, a flexible budget is designed to be adaptable to changes in sales volume, production volume, or other measures of business activity. Over time, though, your actual production, sales, and revenue will change. These changes can be due to variations such as changing inventory costs, supply chain concerns, and market conditions.