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Why a Flexible Budget May Be a Good Option for Your Business

what is a flexible budget

A flexible budget is one that takes into account your actual production and revenue rather than what you originally projected. This represents your best guess at what will be spent and what will be earned. A flexible budget is a budget that changes based on your actual production or revenue.

The Beginners Guide to Budgeting and Forecasting

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 customer, account, and department mapping to ensure your variance reports can get to the most granular level with just a few clicks. If you’ve decided that a flexible budget is the right path for your organization, here’s how to successfully implement one. Flexible budget variance is the difference in spending or revenue between the base or original budget and the budget that was flexed into. No matter which type of budget model you choose, tracking your finances is what matters most.

Why do companies use flexible budgets?

Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. The static budget is intended to be fixed and unchanging for the duration of the period, regardless of fluctuations that may affect outcomes. 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. Fixed expenses such as rent, utilities, equipment costs, and salaries usually make up a significant portion of any business budget.

  • Creating a business budget, particularly a flexible budget, requires some familiarity with the accounting process and is best left to experienced accountants and bookkeepers with knowledge of cost accounting.
  • 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.
  • If so, one can integrate these other activity measures into the flexible budget model.
  • It doesn’t provide the full level detail that a flexible budget would, but it does provide flexibility and a more accurate, up-to-date budget than a static budget.
  • Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula.

Not All Costs Are Variable

  • While this results in a longer initial budget time, it makes for a much faster overall budgeting process, since you (ideally) don’t need to re-forecast scenarios or calculate new projections.
  • The second budget is our flexible budget – using all of the same assumptions about sales price, cost of raw materials and cost of labour – but adjusted for the actual units sold.
  • The variable cost ratio compares the costs of increasing production to the resulting revenue.
  • Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes.
  • 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.
  • Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter.

Understanding and evaluating your previous budgets will help you create a more accurate future budget, which makes everybody’s job easier and stabilizes the company’s finances. And with a flexible budget, you have multiple contingencies to stay on plan. 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.

what is a flexible budget

For control purposes, the accountant then compares the budget to actual data. Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia. Ambitious finance leaders engage with Prophix to drive progress and do their best work.

Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance. Actual revenues or other activity measures are entered into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs. The ability to provide flexible budgets can be critical in new or changing businesses where the accuracy of estimating sales or usage my not be strong. For example, organizations are often reporting their sustainability efforts and may have some products that require more electricity than other products. The reporting of the energy per unit of output has sometimes been in error and can mislead management into making changes that may or may not help the company. Sales has a budget, marketing has a budget, product has a budget, and so on.

what is a flexible budget

Creating a flexible budget begins with assigning all static costs a fixed monthly value, and then determining the percentage of revenue to assign to your variable costs. 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. Since the flexible https://thearizonadigest.com/navigating-financial-growth-leveraging-bookkeeping-and-accounting-services-for-startups/ budget restructures itself based on activity levels, it is a good tool for evaluating the performance of managers – the budget should closely align to expectations at any number of activity levels. It is also a useful planning tool for managers, who can use it to model the likely financial results at a variety of different activity levels. The flexible budget will show different possibilities for variable expenses and revenue.

Compare your budget model with actual expenses with variance analysis

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. Lobster Instant Noodles make instant ramen noodles in cups that are commonly eaten by university students across the world. Simply add boiling water, close the lid for 3 minutes and you’ve got an instant meal. The business had planned to sell 25,000 units in 2022 at a price of $6.50.

  • Companies around the globe experienced this in March 2020 when the COVID-19 pandemic required lockdowns that grounded much of the economy to a halt.
  • 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.
  • Some companies have so few variable costs of any kind that there is little point in constructing a flexible budget.
  • In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget.
  • Uncertain market conditions make the case for the flexible budget, as it’s more certain that a single plan won’t be followed.
  • 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.

This can help businesses make better decisions about their operations, identify areas where they can improve efficiency or reduce costs, and better plan for future growth. A flexible budget is a budget that adjusts for changes in the level of activity or output. Unlike a static budget, which is based on a fixed level of activity or output, a flexible budget is designed to be adaptable to changes in sales volume, production volume, or other measures of business activity. While creating and maintaining real-time Navigating Financial Growth: Leveraging Bookkeeping and Accounting Services for Startups adjustments can be somewhat time-consuming, there’s tangible value in terms of more efficient budget allocations and more agile decision-making. After each month (or accounting period) closes, a flexible budget assumes you’ll compare projected revenue to actual results and adjust the next month’s expenses accordingly. The difference between your projected and actual figures gives you the flexible budget variance, an essential metric to understand how well your predictions align with your actual performance.

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. Any budgeting method works here—you can use incremental budgeting for a basic flexible budget, or zero-based budgeting to completely rework the budget. Flexible budgets are efficient because they do all the work while you’re making the budget. While this results in a longer initial budget time, it makes for a much faster overall budgeting process, since you (ideally) don’t need to re-forecast scenarios or calculate new projections. Because you’ve planned for variances in the budget, you know exactly which path to follow to maintain the trajectory that’ll keep the company on plan. Historically financial modeling has been hard, complicated, and inaccurate.

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