Having a few clearly defined and well-calculated lines in the sand gives you a quick and dirty way to move forward while more complex budget re-calculations are performed. Cost per unit, cost per customer acquisition, number of product launches — many different dimensions can be used to set intelligent limits for volatile times. If the factory has to use more machine hours one month, its budget should logically increase.
- The flexible budget can be compared to what’s known as the static budget.
- The fixed costs stay the same, while the variable costs are used to create budget scenarios.
- The management might assign a 7% commission for the total sales volume generated.
- Flexible budgeting puts more pressure on you to have rock-solid financial assumptions as you tie various line items together in the model.
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 have the ability to constantly restructure themselves around changes in activity. This adaptability allows flexible budgets to offer a precise picture of company performance, seeing as they’re always working with the most current data and details. A flexible budget adjusts based on changes in actual revenue or other activities.
Static Budget vs Flexible Budget
Imagine your product goes viral on social media and gains unexpected popularity overnight, now there is a demand for 20 units next month, which would cost $20 to make. 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. In budgeting meetings, McFall frequently sees people getting into minutiae that have nothing to do with the overall evolution of the budget or the financial health of the company.
Instead of using a dollar amount, they can allocate 10% of the company’s revenue. Flexible budgets come with advantages like their usability in variable cost environments, their detailed picture of performance, and their overall efficiency for budgeting teams. A flexible budget will show the variance in both revenue and spending.
Not All Costs Are Variable
Flexible budgets are dynamic systems which allow for expansion and contraction in real time. They take into account that a business is an organic, growing system and that life is not predictable. Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed for future periods. The level of activity in terms of production is required to prepare a budget. Total net income changes as the amount for each line on the income statement changes.
A flexible budget lets you adjust to global trends and economic changes rather than trying to anticipate when those will happen (and likewise brace for their impact). Your flexible budget would then look at revenue, based on both units sold and sales price. For example, your flexible budget may have three columns that show the number of units sold, the sales price, and total revenue. It is helpful for manufacturing industries where costs change with a change in activity level. Companies must involve experts to make accurate budgets, ensuring there is less scope for error and improving variance analysis.
Then the budgeting staff completes the remainder of the budget, which flows through the formulas in the flexible budget and automatically alters expenditure levels. The budgeting process doesn’t have to be excessively time-consuming. Instead of enduring the cumbersome time-suck of using standard spreadsheets, software like NetSuite Planning and definition and different types of income tax Budgeting offers the advanced capabilities required to create flexible budgets that meet your needs. Companywide financial data is kept in one centralized and up-to-date location, offering greater visibility over financial plans, forecasts and budgets. This also makes budget monitoring and maintenance an easier and more collaborative process.
Static vs. Flexible Budgeting
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. After a disastrous start to the 2020 season, the MLB was forced to regroup. Now, the league is looking to tweak its plan(opens in new tab) to adopt best practices from other sports, address shortcomings and better fit the changing circumstances. As companies get larger, with more sophisticated finance operations, more data and more people involved, expectations should be higher.
If a manager is only responsible for a department’s costs, to include all the manufacturing costs or net income for the company would not result in a fair evaluation of the manager’s performance. If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance. 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.
Flexible budgets make sense
In a flexible budget, there is no comparison of budgeted to actual revenues, since the two numbers are the same. The model is designed to match actual expenses to expected expenses, not to compare revenue levels. There is no way to highlight whether actual revenues are above or below expectations. The cost of production is the sum of prime cost and other direct costs and fixed costs. One of the concepts used here is the range of activity levels within which a relationship between cost and activity level persists. Managers may decide the range of activities depending on the capacity of the organization and the most favorable range.
This represents your best guess at what will be spent and what will be earned. Note that the shipping department’s total static budget variance is $8,000 unfavorable since the actual expenses of $508,000 were more than the static budget of $500,000. The department’s total flexible budget variance is $4,000 favorable since the actual expenses of $508,000 were less than the flexible budget of $512,000.
For example, if your production of widgets is 100 per month, your variable admin costs may be $200 per month. However, if your production of widgets is 200 per month, your variable admin costs would increase to $400. But two months into the fiscal year, a competitor closes its doors. Suddenly, there is only one company to meet demand for widgets, resulting in actual sales of 200 units per month. The actual revenue the widget company is taking in has doubled—but the production costs would also go up.
Advantages and Disadvantages of Flexible Budget
Maybe you spent less on facilities than expected, but new tariffs mean manufacturing is not going to make its numbers. By investing what you would have spent on utilities and in-office food service on a one-time effort to find and sign on alternate suppliers, you set that team up for more predictable costs going forward. For example, a company expects to make $2,000 when they produce 500 units of a product. If that company produces 1,000 units and expects to make $4,000 but instead makes $4,200, then the variance would be $200. Flexible budgeting is an important tool for most small businesses. Learn how it can help your business respond to the ups and downs of the marketplace.
- The company wants to prepare based on a scheduled activity level of 70% of the production capacity.
- With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support.
- When using a static budget, some managers use it as a target for expenses, costs, and revenue while others use a static budget to forecast the company’s numbers.
- Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance.
When people know there’s not an iron-clad expectation to stay within a static line item, there’s temptation to constantly ask for more. Instead of singular “10% net profit growth,” have a meaningful debate to determine a market-ready range (say 8–12% or any other range that your analysis suggests). Or replace a “15% market share” with a range that would give flexibility to your team while still providing focus and discipline — perhaps, 12–18%, or 11–17%. Static budgets are often used by non-profit, educational, and government organizations since they have been granted a specific amount of money to be allocated for a period. For control purposes, the accountant then compares the budget to actual data. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration.
Categories of Expenses in a Flexible 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. For SaaS companies, flexible budgeting relates more to the cost of revenue — the actual costs for creating and delivering a product/service to customers. The cost of revenue involves hosting fees, service and cloud fees, and website development.
Static budgets may be more effective for organizations that have highly predictable sales and costs, and for shorter-term periods. A static budget helps to monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance. By keeping each department or division within budget, companies can remain on track with their long-term financial goals. A static budget serves as a guide or map for the overall direction of the company.