Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes. So if the initial static budget called for 25% to be spent on marketing, the flexible budget will maintain that same percentage for marketing whether the budget increases or decreases. The flexible budget shows an even higher unfavorable variance than the static 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. 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.
Unlike a static budget, a flexible budget includes both fixed and variable costs that can be adjusted based on revenue percentage or production cost incurred throughout the course of the budget period. A flexible budget adjusts based on changes in actual revenue or other activities. 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.
It has been “flexed,” or adjusted, based on your real production levels. The original budget for selling expenses included variable and fixed expenses. To determine the flexible budget amount, the two variable costs need to be updated. The new budget for sales commissions is $10,500 ($262,500 sales times 4%), and the new budget for delivery expense is $1,750 (17,500 units times 10%). These are added to the fixed costs of $12,500 to get the flexible budget amount of $24,750. A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses.
The flexible budget cost of goods sold of $196,875 is $11.25 per pick up truck times the 17,500 trucks sold. The lack of a variance indicates that costs in total (materials, labor, and overhead) were the what is a bookkeeper and when do i need one same as planned. The next step is to combine the variable and fixed costs in order to prepare a new overhead budget report, inserting the new flexible budget results into the overhead budget report.
Intermediate Flexible Budget
The actual revenue the widget company is taking in has doubled—but the production costs would also go up. The flexible budget for the quarter would reflect both these things. If such predictive planning is not possible, there will be a disparity between the static budget and actual results.
To prepare the flexible budget, the units will change to 17,500 trucks, and the actual sales level and the selling price will remain the same. Given that the variance is unfavorable, management knows the trucks were sold at a price below the $15 budgeted selling price. 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. In the original budget, making 100,000 units resulted in total variable costs of $130,000.
To prepare a flexible budget, you need to have a master budget, really understand cost behavior, and know the actual volume of goods produced and sold. A flexible budget is a tool used in the preparation of financial statements. It allows companies to prepare budgets under different scenarios to be adjusted for future projections. Accountants enter actual activity measures into the flexible budget at the end of the accounting period. It subsequently generates a budget that ties in specifically with the inputs.
Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Flexible budgets can be very useful, but they do have some downsides. Let’s suppose the production machinery had to operate for 4,500 hours during February.
For each category of overhead, Steve computed a variance, identifying unfavorable variances in indirect materials, indirect labor, supervisory salaries, and utilities. Since the flexible 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. A flexible budget cannot be preloaded into the accounting software for comparison to the financial statements. Only then is it possible to issue financial statements that contain budget versus actual information, which delays the issuance of financial statements. At its simplest, the flexible budget alters those expenses that vary directly with revenues.
- Spending variance is the difference between what you should have spent at your actual production level and what you did spend.
- If such predictive planning is not possible, there will be a disparity between the static budget and actual results.
- These variances are used to assess whether the differences were favorable (increased profits) or unfavorable (decreased profits).
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What is the difference between a flexible budget and an actual budget?
Although with the flexible budget, costs would rise as sales commissions increased, so too would revenue from the additional sales generated. Unlike a static budget, a flexible budget changes or fluctuates with changes in sales, production volumes, or business activity. A flexible budget might be used, for example, if additional raw materials are needed as production volumes increase due to seasonality in sales.
Variance Analyses: Tale of Two Coffee Shops
The company knows its variable costs per unit and knows it is introducing its new product to the marketplace. Its estimations of sales and sales price will likely change as the product takes hold and customers purchase it. Big Bad Bikes developed a flexible budget that shows the change in income and expenses as the number of units changes. It also looked at the effect a change in price would have if the number of units remained the same.
Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information. When preparing budget reports, it is important to include in the report the items the manager can control. 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. 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.
Time Delay Issues
Estimate the profits of the company when the factory works at 60% and 80% capacity, and offer your critical comments. Learn how it can help your business respond to the ups and downs of the marketplace. A static budget stays at a single amount regardless of how much activity there is. Consider Kira, president of the fictional Skate Company, which manufactures roller skates.
In a static budget situation, this would result in large variances in many accounts due to the static budget being set based on sales that included the potential large client. A flexible budget on the other hand would allow management to adjust their expectations in the budget for both changes in costs and revenue that would occur from the loss of the potential client. The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance. This ability to change the budget also makes it easier to pinpoint who is responsible if a revenue or cost target is missed. A static budget is one that is prepared based on a single level of output for a given period.
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A static budget–which is a forecast of revenue and expenses over a specific period–remains unchanged even with increases or decreases in sales and production volumes. However, when compared to the actual results that are received after the fact, the numbers from static budgets can be quite different from the actual results. 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. In order to create an accurate business budget, you’ll need to separate fixed costs from variable costs since a flexible budget is only concerned with variable expenses, such as production levels, materials and labor. A flexible budget is designed to change based on revenue or production levels.
Semi-variable expenses remain constant between 45% and 65% capacity, increasing by 10% between 65% and 80% capacity, and by 20% between 80% and 100% capacity. For example, a widget company might start out the year with a static planning budget that assumes that the cost to produce 10 widgets is $100, and the company will produce 100 units per month. Each unit will bring in a net profit of $50, so the net profit per month will be 100 X 50, or $5,000. The company also knows that the depreciation, supervision, and other fixed costs come to about $35,000 per month. A flexible budget is a budget or financial plan that varies according to the company’s needs.
