For example, a company that typically produces 200 units can determine the impact of the changes if they produce more units by creating three budgets which measure 100%, 80%, and 120% in order to garner a range. The business can then use the figures from the three budgets to create a new one for the following year. Costs that are below budget are good, as they are considered favorable as long as they implement the correct scenario for the volume.

Also, a great deal of time can be spent developing cost formulas, which is more time than the typical budgeting staff has available in the midst of the budget process. Whether switching to a flexible budgeting process from a static model or starting from scratch, there are keys to success. There is a place for static budgets when costs are largely fixed — think rent, website, insurance. However, the benefits of rigidity fade when no room is left for emergencies, opportunities and strategic shifts.

What is a Flexible Budget?

Flexible budgets have a reputation for being more time-consuming than other 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. While this isn’t a reason to avoid flexible budgeting altogether, it’s good to keep in mind outsourcing bookkeeping guide as you consider how and when to implement this kind of budgeting strategy. If your company regularly conducts a flux analysis, syncing this process with your flexible budget creation can help save time. The difference between a flexible budget and a static budget is that static budgets deal with fixed budget amounts that don’t vary as other line items increase and decrease.

A static budget may be more inaccurate than a flexible budget if the actual volumes vary from the projected volumes. This could occur since it doesn’t consider current sales or other changes that could impact the company’s revenue. On the other hand, flexible budgets can vary and take these changes into consideration. If, however, the cost was identified as a fixed cost, no changes are made in the budgeted amount when the flexible budget is prepared.

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. Some expenditures vary with other activity measures than revenue. For example, telephone expenses may vary with changes in headcount. If so, one can integrate these other activity measures into the flexible budget model. Then, upload the final flexible budget for the completed period into your accounting system so you can compare it with actual expenses through a variance analysis(opens in new tab).

Understanding a Static Budget

Here’s a quick punch list of the pros and cons of flexible budgets. The flexible budget at first appears to be an excellent way to resolve many of the difficulties inherent in a static budget. However, there are also a number of serious issues with it, which we address below. Traditionally, companies spend weeks or months creating an annual budget that’s more chiseled in stone than fluid and flexible. For the personality types that tend to be drawn to finance careers, that certainty provides a blanket of security, with its solid numbers and well-documented milestones.

The fixed costs stay the same, while the variable costs are used to create budget scenarios. 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. Thus, the variable portion of the cost of goods sold is 30% of revenues. Once the budget period has been completed, ABC finds that sales were actually $9 million.

What Are Flexible Budgets? 4 Best Practices

The company can then create a flexible budget to allocate 10% of its earned revenue instead of a specific fixed amount. Budgeting is an important part of business finances as well as personal finances. While the general concept of budgeting may be the same, it can be used for many different purposes. Because of this, there are several different types of budgeting systems that can be used. Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement.

Businesses are finding that to be true when it comes to budgeting. All the forward-looking planning in the world can go right into left field in the face of, say, a global pandemic. Businesses of all sizes are realizing they need to be nimbler and more flexible in their planning, hence the increased adoption of rolling forecasts. One example is a company that uses the budget to allocate funds for marketing purposes.

Ways to Bring Flexibility to Budgeting

But, in a happier scenario, what if the coffee shop exceeds expectations and operates at 120% of original expected activity? However, to see these numbers in action, let’s say, hypothetically, a pandemic hits. The coffee shop’s activity is then reduced to 70% of what was expected. As opposed to 22,750 customers, there are only 15,925, bringing revenue down to $47,775. It can also be calculated as per-unit variable cost over the per-unit sales cost, or $.75 / $3.

• Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula.
• Revenue is still calculated at month end so costs cannot be retroactively adjusted.
• Flexible budgeting is a budgeting process which consists of preparing multiple budget scenarios that are adjusted for different volumes.
• The difference between a flexible budget and a static budget is that static budgets deal with fixed budget amounts that don’t vary as other line items increase and decrease.

A static budget stays at a single amount regardless of how much activity there is. 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. 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. Flexible budgets are best used for startups that have a number of variables such as manufacturing, and others that have revenue based on seasonality, as costs are directly impacted by demand. These points make the flexible budget an appealing model for the advanced budget user.

COMPANY

For sake of illustration, let’s use a very simple, three-month budget for a coffee shop as an example. Over this time period, the shop expects an average of 250 customers per day (22,750 total), each buying one cup of coffee that costs $3. Do executives have the stomach to say no, even when there is funding to undertake an unbudgeted project? The range of activity for which a budget is to be prepared is decided.

• Mosaic eliminates silos by connecting to your ERP, CRM, HR system, and billing systems to centralize financial data from across departments.
• The hours of analysis and modifications could be rendered futile if predicted conditions, trends or objectives change.
• This includes identification of the actual quantity of the output.
• Traditionally, companies spend weeks or months creating an annual budget that’s more chiseled in stone than fluid and flexible.
• 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.

It does not consider the possible fluctuations or changes in the costs. The amounts listed on this budget do not change, despite any other changes taking place. 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. 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.

When these budgets are prepared and adjusted according to change in activity, it is called a flexible budget. The original budget assumed 17,000 Pickup Trucks would be sold at $15 each. To prepare the flexible budget, the units will change to 17,500 trucks, and the actual sales level and the selling price will remain the same. Given that the variance is unfavorable, management knows the trucks were sold at a price below the $15 budgeted selling price.

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. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound. This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue.