6 Advantages and Disadvantages of Flexible Budgeting

Flexible budgets enable more accurate assessment of managerial and organizational perfor­mance. It helps to set the prices and quotations for a business contract. Fixed cost, for example, rent, insurance premium, etc., remains the same every month, irrespective of the actual machine hour used. StockMaster is here to help you understand investing and personal finance, so you can learn how to invest, start a business, and make money online.

However, to see these numbers in action, let’s say, hypothetically, a pandemic hits. The coffee shop’s activity is then reduced to 70% of what was expected. As opposed to 22,750 customers, there are only 15,925, bringing revenue down to $47,775.

Module 9: Operating Budgets

The flexible budget allows estimates for expected expenses for costs that may fluctuate, such as utilities. Using this budgeting process is more effective since it provides a realistic outlook on the projected budget. Revenues and expenses are constantly adjusted in flexible budgets for current operating conditions. New environmental regulations might increase the costs of production and could require the purchase of different types of machines. Weather conditions could increase shipping costs and result in delayed shipments to customers. Enter actual activity measures into the model after an accounting period has been completed.

• More than likely, you dutifully prepare a static budget each year and put it in your desk drawer – and it’s not seen again until it’s time to prepare a new budget.
• Retail environments would be ideal in this case whereby any overhead activity or cost can be separated and treated as if they were a fixed cost.
• This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue.
• The factors of production are prone to certain limitations and are not in human control.
• This approach means you’ll easily be able to make changes in the budgeted expenses that are directly tied to your actual revenue.

Unfavorable variance is an accounting term that describes instances where actual costs are greater than the standard or expected costs. A static budget incorporates expected values about inputs and outputs that are conceived prior to the start of a period. Peggy James is a CPA with over 9 years of experience in accounting and finance, including corporate, nonprofit, and personal finance environments. She most recently worked at Duke University and is the owner of Peggy James, CPA, PLLC, serving small businesses, nonprofits, solopreneurs, freelancers, and individuals.

Pros of a Static Budget

Flexible budgeting is a budgeting process which consists of preparing multiple budget scenarios that are adjusted for different volumes. These adjustments occur due to other changes within the activities of the business and allow a flex in order to have room in the budget for these alterations.

The flexible budget can be used for the determination of budgeted sales, costs, and profits at different activity levels. Plot the variable and fixed costs for the budgeted activity level and this will lead to the creation of a flexible budget. 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 variance for operating income can be determined just as any other variance.

Definition of Flexible Budget

In the case of a typical business, if it is newly started, it becomes tough to predict the demand for the products/services accurately. But this can be dealt with by putting a Flexible budget in place. 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 https://intuit-payroll.org/ need to build an accurate, customized financial model. You can work towards automating your budget since your expenses are directly tied to your revenue. 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. The above scenario is the initial budget assuming 100% activity.

• If you buy a new pair of jeans in September, the odds are you won’t need another in October.
• The procedure for drawing up a flexible budget is quite straight forward.
• Its estimations of sales and sales price will likely change as the product takes hold and customers purchase it.
• This is the section that accounts for utilities, student loan payments, car payments and other fixed expenses that you can’t easily modify.
• She is a graduate of Bryn Mawr College (A.B., history) and has an MFA in creative nonfiction from Bennington College.

● Allows you to roll with the punches so you can easily address changes in your circumstances and market conditions, such as business volume and market fluctuations. That means, if efforts scale up to $15 million, then the variable portion of the costs of goods sold moves from $3 million to $4.5 million. Let’s start with an example of flexible flexible budgeting advantages budget in practice. What you’re looking to do is account for any unanticipated expenses that came up in the previous month, and to do so in a way that preserves your financial priorities. The factors of production are prone to certain limitations and are not in human control. Making a prediction based on these resources can be difficult.

Accounting for Managers

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. The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance.