A Small Business Guide to Flexible Budgets

Flexible budgets are usually prepared at each business analysis period , rather than in advance. 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 , each buying one cup of coffee that costs $3. It may also incorporate the monetary value of the units of materials to be purchased for producing the goods and services as per its Production Budget. However, the objective of this budget is to see that the required raw materials are available for production as and when they are required by the production department/s.

The cost formula for a variable cost is the cost per unit times the quantity driving the cost, usually sales or production. For example, assume that shipping is $4 for every unit sold. Shipping is a variable cost since it is always $4 per unit but the total depends on how many units are sold. The cost formula for shipping would be $4 per unit sold, which is noted as $4Q .

Flexible Budgets

Leed Company’s manufacturing overhead cost budget at 70% capacity is shown below. Leed can produce 25,000 units in a 3 month period or a quarter, which represents 100% of capacity. Leed Company’s manufacturing overhead cost budget at 70% capacity is shown below. A flexible budget makes it easier for businesses to see more variances. During your higher-earning months, you would save for the months where your income isn’t as high. The following flexible budget reveals the expected aggregate expense levels. In reality, supporting flexible budget documents would resemble the comprehensive budget documents portrayed in the prior chapter.

• 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.
• Such comprehensive documents would provide the information necessary to manage the smallest of operating details that must be adjusted as production volumes fluctuate.
• Most companies use fixed budgets, which means that they routinely deal with large variations between actual and budgeted results.
• Each project or activity is to be justified of its necessity for its inclusion in the budget.
• Wanda Wallace owns ReStore a furniture repair and restoration shop.
• Businesses of all sizes are realizing they need to be nimbler and more flexible in their planning, hence the increased adoption of rolling forecasts.

It is prepared by considering the king-term and short-term requirement of assets. Capital expenditure budget also forecasts the need of asset replacement, delays in purchasing new assets, and alternative means to satisfy the production requirement.

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Total Mfg Overhead$92,500$95,000$97,250$100,000A flexible budget can be prepared for any level of activity. The advantage to a flexible budget is we can create a budget based on the ACTUAL level of production to give us a clearer picture of our results by comparing the flexible budget to actual results. This analysis would compare the actual level of activity so volume variances are not a factor and management can focus on the cost variances only. We will discuss this analysis next in the performance report. Instead of estimating production levels, use the actuals from the previous month to create your flexible budget. For instance, if your company produced 50,000 units in January, and you want to budget for 75,000 units in February, you have to look at your variable costs.

A flexible budget is the planning budget reforecasted using the actual level of activity instead of the planned level of activity. The flexible budget uses the same cost formulas as the planning budget but is prepared using the actual sales quantity as the cost driver. The reforecasted flexible budget adjusts revenue and expenditure targets to match the actual level of activity. Reforecasting enables the user to compare flexible budget targets to actual results and evaluate actual performance.

How to create and implement a flexible budget for your business

Flexible budget variances are used in the performance evaluation phase. A variance is any discrepancy found when two items are compared. There are two main types of variances evaluated when flexible budgets are analyzed—activity variances and revenue or spending variances.

It is usually not appropriate to use a planning budget during the performance evaluation phase of operations. The reason is that the actual quantity sold or produced is rarely the same as the estimated quantity projected in the planning budget. Performance evaluation occurs at the end of the budget cycle and is the process of comparing the budgeted estimates to the actual results. While planning budget quantities are usually close to actual results, it is nearly impossible to accurately predict what the actual sales quantity will be before the period begins. If the planning budget and actual results are based on different sales quantities, they cannot be directly compared. For example, if the actual quantity sold at the end of the period is higher than the budgeted amount, it makes sense that both actual revenue and expenses will be higher than the budgeted amounts. But it is difficult to determine how much higher revenue and expenses should be or if revenue targets and expense limitations were in fact met.

Encourages more spending habit even if it is not required. This happens because the funds for different activities are increased without any cost analysis. Under this method, a Budgeted Balance Sheet is prepared for the Budget Period incorporating all the items of liabilities, capital and assets except cash. Since this method considers only the anticipated cash receipts and payments, it is implied fixed budgets are also known as flexible budgets that all accruals and adjustments are not considered for preparing the Cash Budget. That means, advance payments and receipts are taken into consideration for the purpose of preparing the Cash Budget irrespective of whether these cash flows pertain to the current year or not. Further, the expenses incurred but not paid and the incomes earned but not received are excluded from the Cash Budget.

Each project or activity is to be justified of its necessity for its inclusion in the budget. No past activity is included the current budgets unless there is justification for its inclusion. It is an effective tool of planning and control of activities and costs during the budget period. Fixed budget is based on the assumption that there will be no change in the level of activity.