After each month (or set period) closes, you compare the projected revenue against the actual revenue and adjust the next month’s expenses accordingly. Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed flexible budget example for future periods. Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. On the other hand, some overhead costs, such as rent, are fixed; no matter how many units you make, these costs stay the same.

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. 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.

Financial and Managerial Accounting

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. 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. Another benefit of using a flexible budget is that it can help you communicate your budget with your stakeholders, such as staff, managers, board members, funders, and regulators. By showing how your budget changes with the volume and activity level of your organization, you can explain your assumptions, expectations, and performance more clearly and transparently.

A flexible budget provides budgeted data for different levels of activity. 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?

Establish your budget formulas

Steve made the elementary mistake of treating variable costs as fixed. After all, portions of overhead, such as indirect materials, appear to be variable costs. If Skate increased production from 100,000 units to 125,000 units, these variable costs should also increase.

The flexible budget shows an even higher unfavorable variance than the static budget. This does not always happen but is why flexible budgets are important for giving management an indication of what questions need to be asked. Accountants enter actual activity measures into the flexible budget at the end of the accounting period.

Flexible Budget

Subsequently, the budget varies, depending on activity levels that the company experiences. To keep the example simple, we assume that the first four costs are strictly variable and we will calculate a budget per unit for these costs. On the other hand, the last two costs, depreciation and supervision, are fixed costs and are assumed to be constant over the entire relevant range of activity meaning they do not change based on volume. The table below shows the calculations for units produced at 70% capacity and calculates the variable cost per unit for all variable costs. 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.

To ease the process, McFall shared several startup budgeting lessons he’s learned over the course of his 25-year career. Let’s face it  – business moves fast, and we have to be flexible for what is thrown at us. Experts are adding insights into this AI-powered collaborative article, and you could too.

To compute variances that can help you understand why actual results differed from your expectations, creating a flexible budget is helpful. A flexible budget adjusts the master budget for your actual sales or production volume. Flexible budgets have a reputation for being more time-consuming than other budgeting models.

You can also compare your flexible budget with other benchmarks or standards, such as industry averages, best practices, or quality indicators. You can also solicit input and suggestions from your stakeholders, and incorporate them into your flexible budget. By doing https://www.bookstime.com/ so, you can ensure that your flexible budget is up to date, reliable, and useful for your financial management. To prepare a flexible budget, you need to have a master budget, really understand cost behavior, and know the actual volume of goods produced and sold.

This can help businesses make better decisions about their operations, identify areas where they can improve efficiency or reduce costs, and better plan for future growth. 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. What is not known from looking at it is why the variances occurred.

It’s also important to request accountability for all changes made to this budget in order to keep it working for you. Flexible budgets offer close monitoring of expenses versus revenue, and they allow for the opportunity to test things out and see what might work and what won’t without rigid financial constraints. 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. It analyses the costs with respect to the variations in the output levels.

Static Budgets vs. Flexible Budgets

A flexible budget is a budget or financial plan that varies according to the company’s needs. They made it flexible because the specific company’s or department’s needs do not remain static. 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%.

• Managers use a technique known as flexible budgeting to deal with budgetary adjustments.
• A static budget helps to monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance.
• Whether switching to a flexible budgeting process from a static model or starting from scratch, there are keys to success.
• In the original budget, making 100,000 units resulted in total variable costs of $130,000.
• Flexible budgets have the ability to constantly restructure themselves around changes in activity.
• Consequently, a more sophisticated format will also incorporate changes to many additional expenses when certain larger revenue changes occur, thereby accounting for step costs.

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. Sales has a budget, marketing has a budget, product has a budget, and so on. Those siloes make flexible budgeting nearly impossible and limit the strategic value of an over-stretched finance team. But with Mosaic, you can streamline processes and break down siloes to act as a more collaborative partner to everyone in the business.