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Adapt To Changing Conditions With Flexible Budget Variance

flexible budget example

Flexible approach of budgeting can adjust to the variances quickly and result in better controls in operations. The biggest advantage with flexible budgeting is the stress on operational efficiency to achieve the standard targets. Variance analysis in absolute figures cannot reveal the actual causes. The management may also adjust sales prices to achieve the favorable variance provided it doesn’t affect the competitive edge. Budgeting and variance analyses can help management to price the products at an optimum level, meeting the market competitions and covering the production costs. In flexible budgeting, a budget has scenarios for different potential volume levels. During the year, a company compares its actual results to the budget scenario that’s most appropriate based on the actual volume of activity.

The most significant advantage of this budget is that it helps the management of the company to determine the production level in different market and business conditions. Where the actual level of activity is different from that expected, comparisons of actual results against a fixed budget can give misleading results.

What Is A Static Budget?

Flexible budgeting performance report analyzes actual results against the standard budgets. If you have a positive variance, the company produced favorable results and achieved more than it had originally planned. And adverse or negative variance means the organization was not able to achieve its target plans. Because the budget can be made for any activity, the variance also needs to be analyzed separately for each activity. Variance analysis can help management understand the cost drivers and causes of the change whether the change is positive or negative.

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  • A flexible budget is an estimate of revenues and expenses that is prepared for a budgeted activity level and allowed to vary as the activity level changes in the actual results.
  • A more popular approach is to use a partial flex budget for managing and tracking labor costs, he says.
  • Budgeting and variance analysis can help management to price their products at the optimal level while meeting Market competition and covering their production costs.

As with any budget, flexible budgets are simply forecast that may change by the time production actually begins. For instance if the business period covers three months, the static budget is created before the period begins to cover the three months of operation.

What Are The Steps To Developing A Flexible Budget?

Unlike a static budget, a flexible budget includes both fixed and variable costs that can be adjusted based on revenue percentage or production cost incurred throughout the course of the budget period. A flexible budget is a revised master budget based on the actual activity level achieved for a period. The master budget is established before the period begins for planning purposes, and the flexible budget is established after the period ends for control and evaluation purposes. Production managers are evaluated using the flexible budget because the usage of direct materials, direct labor, and manufacturing overhead will depend on the actual number of units produced. Actual revenues or other activity measures are entered into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs.

flexible budget example

In reality, like everything else about running your own business, it’s more complicated than that. In the example above, materials and supplies are budgeted at $1,700 / month, but for two consecutive months shoot well above that. The budget doesn’t tell me why these things have happened, but it’s an essential starting point for figuring that out. Let’s look at an oversimplified small business budget so we have actual numbers to use as an illustration. After that, we’ll look at how a flexible budget is different, then talk about how to create a flexible budget that works for you.

Original Budget: 100% Capacity

This makes Jake really happy, as the net profit for his department is rising along with the increase in sales! Let’s take a look at how a flexible budget can help businesses grow, and offer a better picture of where budgeted expenses should be. A flexible budget is much more realistic than fixed budgets since it gives emphasis on cost behavior at different levels of activity.

With flexible budgets, managers are constantly updating their projections and cost controls with current information. The most significant advantage of flexible budgets over static ones is the ability to adapt to changes in the real world. Nothing ever stays the same, and management has the responsibility to respond to unanticipated adverse conditions and to take advantage of unexpected opportunities.

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Following is the static budget and actual results of Yoga Inc. for the month of April 20X4. James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company’s operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.

flexible budget example

While this is more realistic, many of us benefit from rigidity when it comes to daily, healthy routines. What you’re looking to do is account for any unanticipated expenses that came up in the previous month, and to do so in a way that preserves your financial priorities. It may be tricky to analyze the variances of cost, as the nature of all the expenses may not be the same.

Finding Opportunity In Flexible Budget Variance

We provide example budgets, pros and cons and a guide to getting started. The availability of skilled workers becomes a challenge for the industry. Therefore, flexible budget example many Industries and companies can’t use this budget despite its enormous advantages. Note that both reports are useful for different types of analysis.

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After you get used to flexible budgets, they will become one of your favorite management tools. A company can create a flexible budget to show what it spent and earned, and its total equity , over a long period.

Thoughts On flexible Budget Practical Problems And Solutions

Another way of thinking of a flexible budget is a number of static budgets. For example, a restaurant may serve 100, 150, or 300 customers an evening. 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. 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.

Let’s imagine that a manufacturer has determined what its electricity and supplies costs are for the factory. I want to know if the profits were a fluke based on his unexpected departure or if we really did that well. Add your various sources of income to arrive at a monthly estimate.

This analysis would compare the actual level of activity so volume variances are not a factor and management can focus on the cost variances only. Let us consider the following information regarding the costs that are expected to be incurred by a company in the upcoming accounting period. The company wants to prepare a flexible budget based on an expected activity level of 70% of the production capacity. The number of units that can be prepared at this production capacity is 7000 units. The flexible budget uses the same selling price and cost assumptions as the original budget. The variable amounts are recalculated using the actual level of activity, which in the case of the income statement is sales units.

Static budgets don’t consider the changes that result in a change in the sales or production level. The static budget approach monitors planned and actual results with a focus on achieving a set target. A flexible budget is a budget that is created using a specific cost or formula.

A favorable flexible budget variance is considered a positive outcome for the organization because it means that revenue was higher than expected. Budgets are created as a guide for decision-making, but they are rarely completely accurate. A flexible budget allows for more adjustment as changes in production occur. 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%. The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250.

What are two benefits of using a flexible budget?

Flexible, rolling budgets empower entrepreneurs to cope with change. This nimble planning process lets you adjust spending throughout the year; benefits include less overspending, more opportunities and speedier responses to changing market and business conditions.

Diane Perez is a writer who contributes to various websites, specializing in gardening and business topics, and creates sales copy for private clients. Perez holds a Bachelor of Science in education from the University of Miami. StockMaster is here to help you understand investing and personal finance, so you can learn how to invest, start a business, and make money online.

flexible budget example

Flexible budgets allow the management to adjust our plans and accommodate new targets. In the example, the company may have set a 90% target production rate, changed it to 85%, and still possibly achieved only a 75% production level.

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A static budget stays at a single amount regardless of how much activity there is. Our costs were up to $8,150 and we sold fewer lunchboxes – a mere 432. Let’s pick just a few things from the above sample tables and look at how to create a flexible budget with a few simple categories.

Author: Ken Berry

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