What Are the Pros and Cons of a Flexible Budget?

This series of articles will cover the budgeting approaches flexible budgeting, activity-based budgeting, rolling budgeting, zero-based budgeting, and beyond budgeting. It is made to reference the actual results for calculating variances between the actual and budgeted results. Since it can be adjusted as per the actual activity level, it is easy for a cost manager to identify the budget applicable to the actual activity level at the time of variance analysis.

• Another way of thinking of a flexible budget is a number of static budgets.
• Instead of estimating production levels, use the actuals from the previous month to create your flexible budget.
• Then, they can modify the flexible budget when they have their actual production volume and compare it to the flexible budget for the same production volume.
• They are prepared to represent budgeted costs and revenues based on a specific activity level, such as the number of units produced, percentage of capacity utilized, or number of person-hours devoted.
• A flexible budget, unlike a static one, gives real numbers that tells the business exactly how it’s doing and what it can do better.
• 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.
• The ability to provide flexible budgets can be critical in new or changing businesses where the accuracy of estimating sales or usage my not be strong.

It usually coincides with the fiscal year of the firm and can be broken down into quarters and further into months. If the firm plans for the master budget to roll from year to year, then it would usually add an extra month to the end of the budget to facilitate planning. A master budget includes all of the lower-level budgets within an organization. It gives a firm a broad overview of its finances and is often used as a central planning tool.

What Are the Pros and Cons of a Flexible Budget?

Cost managers adjust the flexible budget to match the actual activity level, enabling them to perform variance analysis based on the flexible budget that aligns with the actual activity level. If you manage a high-level production environment, creating a flexible budget can help mitigate the flexible budget example typical variances found on static budgets. Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter. By the fourth quarter, sales are expected to be strong enough to pay back the financing from earlier in the year.

• Besides, a major demerit of this method is that multiple budgets are prepared for a single activity.
• Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter.
• This content is presented “as is,” and is not intended to provide tax, legal or financial advice.
• The master budget, and all the budgets included in the master budget, are examples of static budgets.
• If you do find yourself in the market for accounting software for your small business, be sure to check out The Ascent’s accounting software reviews and find an application that is a good fit for your business needs.
• For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier.

A flexible budget will show the variance in both revenue and spending. The first schedule to develop is the sales budget, which is based on the sales forecast. The sales budget is not usually the same as the sales forecast but is adjusted based on managerial judgment and other data. Some firms may not use one or another of the budgets, but most use some form of all of them. Service firms, for example, do not typically use production budgets. Which type of budget is best for a small business that’s just starting out?

Assign responsibility for accountability:

Here’s a quick punch list of the pros and cons of flexible budgets. Flexible budgets take time to maintain, with routine monthly reviews and edits. It’s also important to request accountability for all changes made to this budget in order to keep it working for you.

• Big Bad Bikes developed a flexible budget that shows the change in income and expenses as the number of units changes.
• 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.
• 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.
• I think that this is a decision that each business has to make based on its revenue, expenses and how predictable these are.
• It also looked at the effect a change in price would have if the number of units remained the same.

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. A flexible budget on https://www.bookstime.com/accrual-basis the other hand would allow management to adjust their expectations in the budget for both changes in costs and revenue that would occur from the loss of the potential client. The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance.

Flexible Budgeting 101: What Is It & How Does It Work?

Textbook content produced by OpenStax is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License . Flexible budgets can be very useful, but they do have some downsides. Any item that is not in cash, such as depreciation, is ignored by the cash budget.

Because it is a practical approach that is suitable for dealing with real-life situations. Total net income changes as the amount for each line on the income statement changes. 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. 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.

What Is a Master Budget?

The business had planned to sell 25,000 units in 2022 at a price of $6.50. There were direct variable costs for materials $0.80, labour $1.00, overhead $0.50 and selling and administration $0.50. There were also fixed costs of $25,000 related to the factory and $25,000 related to selling and administration. You can gather data for a sales estimate by surveying your sales team, analyzing past trends, or consulting with outside research firms. Once you have compiled a sales budget, you’ll need to develop a production schedule, budget for labor, materials, administration, and other costs, and calculate the cost of goods sold. Also add the capital expenditures budget and the cash-flow budget to arrive at a budgeted balance sheet.

Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com. Let’s imagine that a manufacturer has determined what its electricity and supplies costs are for the factory.

The last step of developing a master budget uses the components you have compiled to create a budgeted balance sheet. The budgeted balance sheet predicts the final effect of costs and sales on the company’s balance sheet. The ending finished goods inventory budget is necessary to complete the cost of goods sold budget and the balance sheet.

Using a flexible budget for the first time may therefore cause some issues with providing the right amount of resources to meet current needs. Rapidly-growing sections of a company may be underfunded, while others are over budgeted until data accumulates and flexible budgets become more accurate at tracking and supporting ongoing trends. Whether a flexible budget or static budget is used by a business is largely determined by the nature of the business cycle and how seasonal it may be. The sophistication of the accounting department to handle the more complex task of managing a dynamic budget is also important in determining whether any frequent and unexpected changes can be properly addressed. In publicly-traded companies, often a combination of both approaches is used. What is not known from looking at it is why the variances occurred.

Actual results are compared to the static budget numbers as one means to evaluate company performance. However, this comparison may be like comparing apples to oranges because variable costs should follow production, which should follow sales. Thus, if sales differ from what is budgeted, then comparing actual costs to budgeted costs may not provide a clear indicator of how well the company is meeting its targets.