What is a Flexible Budget? Advantages & Disadvantages

These variances are used to assess whether the differences were favorable (increased profits) or unfavorable (decreased profits). If an organization’s actual costs were below the static budget and revenue exceeded expectations, the resulting lift in profit would be a favorable result. Conversely, if revenue didn’t at least meet the targets set in the static budget, The Best Guide to Bookkeeping for Nonprofits: How to Succeed Foundation Group or if actual costs exceeded the pre-established limits, the result would lead to lower profits. 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. From these two budgets, a company can develop individual flexible and static budgets for any element of its operations.

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. Though the flex budget is a good tool, it can be difficult to formulate and administer. One problem with its formulation is that many costs are not fully variable, https://quickbooks-payroll.org/non-profit-accounting-definition-and-financial/ instead having a fixed cost component that must be calculated and included in the budget formula. 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. The ending finished goods inventory budget is necessary to complete the cost of goods sold budget and the balance sheet.

Using a Budget to Evaluate Performance

If it used a flexible budget, the fixed portion of the cost of goods sold would still be $1 million, but the variable portion would drop to $2.7 million, since it is always 30% of revenues. The result is that a flexible budget yields a budgeted cost of goods sold of $3.7 million at a $9 million revenue level, rather than the $4 million that would be listed in a static budget. In its simplest form, the flex budget uses percentages of revenue for certain expenses, rather than the usual fixed numbers. This allows for an infinite series of changes in budgeted expenses that are directly tied to actual revenue incurred. 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.

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. Once the budget period has been completed, ABC finds that sales were actually $9 million.

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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. Some firms may not use one or another of the budgets, but most use some form of all of them. Which type of budget is best for a small business that’s just starting out?

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. No matter which https://personal-accounting.org/accounting-for-startups-a-beginner-s-guide/ type of budget model you choose, tracking your finances is what matters most. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration.

Static Budget Definition, Limitations, vs. 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. A flexible budget can help companies account for both variable and fixed expenses, creating a more dynamic process and leading to more accurate forecasts. If the sales-volume variance is unfavorable (flexible budget is less than static budget), the company’s sales (or production with a production volume variance) will turn out to be less than anticipated. The flexible budget is compared to the company’s static budget to identify any variances (or differences) between the forecasted spending and the actual spending.

Unlike a static budget, it adjusts your original budget projection in using your actual sales or revenue. 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.