Flexible Budget Objectives and Importanceof Flexible Budget

In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity. Some of these include increased cost controls, the ability to measure performance of employees and managers, and being able to make adjustments according to costs and profits. The flexible budget shows an even higher unfavorable variance than the static budget.

• It is also called a variable budget because it adjusts with the change in cost driver activities.
• It helps set the expected costs, revenues, and profitability of the business.
• Let us consider the following information regarding the costs expected to be incurred by a company in the upcoming accounting period.
• The cost of production is the sum of prime cost and other direct costs and fixed costs.
• The range of activity for which a budget is to be prepared is decided.
• The variable amounts are recalculated using the actual level of activity, which in the case of the income statement is sales units.

Static budgets are used by accountants, finance professionals, and the management teams of companies looking to gauge the financial performance of a company over time. With flexible budgets, it’s easy to make updates to revenue and activity figures that haven’t been finalized. Because of these seamless workflows (and because of the inherent adaptability), flexible budgets give way to more efficiency than their fixed budget counterparts.

Definition and Examples of a Flexible Budget

The net variance in this example is mainly due to lower revenues. And with out-of-the-box metrics, templates, and dashboards like the forecast vs. actuals dashboard, you can shorten the budget allocation and planning process from two weeks down to two days. Mosaic eliminates silos by connecting to your ERP, CRM, HR system, and billing systems to centralize financial data from across departments. You can access automated retained earnings equation customer, account, and department mapping to ensure your variance reports can get to the most granular level with just a few clicks. If the last few years have taught SaaS companies anything, it’s that sometimes uncertainty is the only certainty there is. Recent years have illuminated how unpredictable the marketplace can be — making it increasingly challenging to create accurate budgets on a recurring basis.

Consequently, the flex budget tends to include only a small number of step costs, as well as variable costs whose fixed cost components are not fully recognized. The first column lists the sales and expense categories for the company. The second column lists the variable costs as a percentage or unit rate and the total fixed costs. The next three columns list different levels of output and the changes in variable costs based on the increased or decreased sales. 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.

How to Set a Flexible Budget

In short, a well-managed static budget is a cash flow planning tool for companies. Proper cash flow management helps ensure companies have the cash available in the event a situation arises where cash is needed, such as a breakdown in equipment or additional employees needed for overtime. Some companies have so few variable costs of any kind that there is little point in constructing a flexible budget.

Instead, they have a massive amount of fixed overhead that does not vary in response to any type of activity. In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget. 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.

When to Use Forecasting Instead of a Budget

For cost forecast, various cost information such as direct material cost, direct labor cost, rate of pay, variable expenses and fixed cost is required. For operating an expenses budget, fixed and variable selling, distribution expenses, fixed expenses, variable expenses, general expenses and administrative expenses are required. 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. For example, let’s say a company had a static budget for sales commissions whereby the company’s management allocated $50,000 to pay the sales staff a commission.

A flexible budget, while much more time-intensive to create and maintain, offers an incredibly precise picture of your company’s performance. Due to the ability to make real-time adjustments, the results present great detail and accuracy at the end of the year. We’ve previously covered the five different types of budget models that businesses can choose from. The flexible budget offers the most customizable experience, allowing it to be easily adopted by many different businesses. A company can also use the flexible budget in order to allocate funds for a particular project. For example, a company may decide to use 10% of its revenue for marketing purposes.

Flexible Budgeting Explained: Definition and Tips for SaaS

Businesses can opt to use one of these based on the need or goals of the company. Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula. Variable costs are usually shown in the budget as either a percentage of total revenue or a constant rate per unit produced. As traffic to the company’s site increases, hosting costs likewise increase. That’s why SaaS companies might make a connection between an AWS budget line item and the assumption for customer growth.

• Businesses of all sizes are realizing they need to be nimbler and more flexible in their planning, hence the increased adoption of rolling forecasts.
• The company can create three budget scenarios with one comparing the same expected results at 100% of capacity, while the others may be in a range, such as 80% and 120%.
• To determine the flexible budget amount, the two variable costs need to be updated.

Spending variance is the difference between what you should have spent at your actual production level and what you did spend. If it is favorable, you spent less than your actual production level should have required. Traditional budgeting harms innovation and renewal in your business, as we found when advising a large manufacturing group setting up a corporate venture fund. Every two years, we conduct “speed of change” research with our clients and community.

It also includes predictive analytics and planning capabilities that let you compare various situations ad hoc. Dashboards make it easy to dig deep into areas like budget, forecasts and actuals to glean detailed insights about business performance and better inform the decision-making process. Once you identify fixed and variable costs, separate them on your budget sheet. Growth rarely happens in exactly the way your original business plan described. The flexible budget can be categorized into three different types. These include the basic flexible budget, intermediate flexible budget, and the advanced flexible budget.

Flexible budgets are usually prepared at each business analysis period (either monthly or quarterly), rather than in advance. With businesses undergoing constant changes, targets and budgets need to become more adaptive. Start by setting your goals and ranges rather than single numbers, setting some firm limits, and shortening the budget cycle. If you don’t want to spend hours tracking and forecasting your budget in spreadsheets, check out our financial modeling tool. Finmark is everything you need to build an accurate, customized financial model.

Although with the flexible budget, costs would rise as sales commissions increased, so too would revenue from the additional sales generated. A flexible budget often uses a percentage of your projected revenue to account for variable costs rather than assigning a hard numerical value to everything. This allows for budget adjustments to occur in real-time, taking into account external factors. At its simplest, the flexible budget alters those expenses that vary directly with revenues. There is typically a percentage built into the model that is multiplied by actual revenues to arrive at what expenses should be at a stated revenue level. In the case of the cost of goods sold, a cost per unit may be used, rather than a percentage of sales.

Flexible budgets make sense

The result is a budget that is fairly closely aligned with actual results. This approach varies from the more common static budget, which contains nothing but fixed expense amounts that do not vary with actual revenue levels. A budget is a financial plan laid out for a specified period, expressed in terms of money. A budgetary system acts as a guide to monitor and control business throughout the year. A detailed summary of all these budgets summarized together is called a master budget.

The columns would continue below with fixed and variable expenses, allowing you to see how your net profit changes based on changes in actual production and revenue. This was exactly our experience when working with a large multinational mining company during the 2015 commodity price slump. With prices falling more than 50% on a number of metals, its annual budgets became obsolete in a matter of days — but the traditional budget adjustment process was complex, slow, and limited in nuance. The traditional budgeting process is tightly connected to the practice of publicly traded companies, so an annual budget is practiced in many companies. That works well in a relatively stable world, but makes it hard to keep up with disruptive changes in prices, foreign exchange rates, new regulations, new technological breakthroughs, and more. A static budget based on planned outputs and inputs for each of a company’s divisions can help management track revenue, expenses, and cash flow needs.