This type of flexible budget takes into account how changes in activity levels affect all costs and provides the most accurate picture of expected costs at different levels of activity. Flexible invoice templates in adobe illustrator budgets calculate, for example, different levels of expenditure for variable costs. Subsequently, the budget varies, depending on the activity levels that the company experiences.
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The choice between the two depends on business requirements for accuracy and adaptability versus the desire for a simpler budgeting process. Flexible budgets have a reputation for being more time-consuming than other accounting definition budgeting models. That’s because flexible budgets require continual upkeep and maintenance — you’re constantly having to keep an eye out for fluctuations and then execute those changes as quickly as you can.
What is a Flexible Budget in Accounting?
With a flexible budget, it’s easy to show that while costs for a month might have been much higher than budgeted, so were sales – justifying the increase. You can also study the monthly adjustments and notes to more accurately plan for future costs. 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. If so, one can integrate these other activity measures into the flexible budget model.
Optimal Usability in Variable Cost Environments
Accountants enter actual activity measures into the flexible budget at the end of the accounting period. It subsequently generates a budget that ties in specifically with the inputs. Mosaic automatically aggregates and consolidates all your financial data in real time, giving you a better starting point for the budget vs. actuals process so you can dig into the causes of budget variances more effectively. 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. Due to its flexibility and response to marketplace and company changes, flexible budgeting requires ample attention.
Advantages of flexible budgeting
Thousands of people have transformed the way they plan their business through our ground-breaking financial forecasting software. If the factory has to use more machine hours one month, its budget should logically increase. Conversely, if it uses them for fewer hours, its budget should reflect that decline. But to really fall https://www.quick-bookkeeping.net/calculating-the-issue-price-of-a-bond-using-the/ into strategic finance and budgeting, rather than asking if your budget should be flexible or static, incremental or strategic, you should focus on what line items you can forecast with a flexible method. More than likely, specific sections of your balance sheet or income statements could benefit from a bit more flexibility.
- 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.
- One problem with its formulation is that many costs are not fully variable, instead having a fixed cost component that must be calculated and included in the budget formula.
- Additionally, flexible budgets have a lack of accountability to some degree since they are so fluid and open to change.
- After each month (or set period) closes, you compare the projected revenue against the actual revenue and adjust the next month’s expenses accordingly.
Now let’s illustrate the flexible budget by using different levels of volume. If 5,000 machine hours were necessary for the month of January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the machine hours in February are 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH).
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. Flexible budgeting is an adaptable budgeting method that enables businesses to modify expense constraints in real-time according to changes in costs, production, sales, or other factors. Flexible budgeting is a hybrid approach to strategic planning, as it begins with a static framework — based on costs that aren’t likely to change — and layers a flexible budgeting system on top that allows other costs to fluctuate. 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.
However, this approach ignores changes to other costs that do not change in accordance with small revenue variations. Consequently, a more sophisticated format will also incorporate changes to many additional expenses when certain larger revenue changes occur, thereby accounting for step costs. By incorporating these changes into the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity. Flexible budgets are especially helpful in environments where costs are closely aligned with the level of business activity. SaaS businesses typically work with costs like hosting fees and site development, so when website traffic starts to increase, so do those hosting costs.
The benefit of a flexible budget is that it provides a more accurate picture of a business’s performance by adjusting for changes in activity levels. 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. While flexible budgets are often used for manufacturing overhead, they’re also pretty common for SaaS businesses.
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. 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. 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.
These points make the flexible budget an appealing model for the advanced budget user. However, before deciding to switch to the flexible budget, consider the following countervailing issues. For control purposes, the accountant then compares the budget to actual data. As mentioned before, https://www.quick-bookkeeping.net/ this model is a much more hands on and time consuming process requiring constant attention and recalibration. Let’s suppose the production machinery had to operate for 4,500 hours during February. Its production equipment operates, on average, between 3,500 and 6,500 hours per month.