Flexible budget definition

Flexible budgets make it easy to update revenue and activity figures as new information comes in. That might include things like headcount timelines or resourcing priorities across teams. The benefit of a flexible budget is that it provides a more accurate picture of a business’s performance by adjusting for changes in activity levels. 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 typically created by identifying the various costs and expenses that vary with changes in activity levels and calculating the expected cost or expense for each level of activity.

Semi-variable costs are treated as a fixed cost up until a certain point, at which point they become what is a flexible budget a variable cost. A flexible budget is a method of budgeting that allows for changes based on the activity and output of the business. Flexible budgets do not fix variances, they help to better plan for the future.

Modelling the Future Through Financial Uncertainty: Why It Matters More Than Ever

Businesses then determine a range of activity levels they might experience, typically including low, medium, and high scenarios. This foresight allows for pre-calculation of expected costs and revenues at each potential operational scale. The relevant range refers to the specific activity range over which assumptions about fixed and variable cost behavior hold true.

What Are Flexible Budgets and How Do They Work?

• That’s why it’s important to choose carefully which parts of your budget should be flexible—and which are better left fixed.
• In a basic flexible budget, finance can build a percentage into the basic model, which they multiply by actual revenues to determine the expenses at a specified revenue level.
• A flexible budget helps you respond to economic shifts and global trends as they happen—instead of trying to predict the timing or impact in advance.
• Only the purely variable expenses vary proportionately with the activity level.
• With an advanced flexible budget, all costs (including fixed and variable costs) are tied to changes in activity.
• The benefit of a flexible budget is that it provides a more accurate picture of a business’s performance by adjusting for changes in activity levels.

This type of budgeting system works by taking a percentage of revenues and expenses and creating a budget based on that. Static budgeting is constrained by the ability of an organization to accurately forecast its needed expenses, how much to allocate to those costs and its operating revenue for the upcoming period. It is mainly used to get a clearer picture of performance by looking at real activity levels.

Thus, for a number of different situations, managers will have calculated their costs and revenues. If an unexpected event does occur, changing the level of activity, the management will be better prepared. Now, if the company’s revenues were to go up by 10%, using a flexible budget, the company will budget for an increase of $5 million in its variable costs. Static budgets may be more effective for organizations that have highly predictable sales and costs, and for shorter-term periods. Learn how flexible budgets dynamically adjust financial plans to changing activity, providing precise performance insights.

Flexible Budget vs. Static Budget

A key tool can come into play to help navigate these uncertainties and make better informed decisions – the flexible budget. The next step is determining the variable cost per unit for each expense category. This requires analyzing historical data and cost drivers to establish how much each variable cost increases per additional unit of activity. For example, if direct materials cost $5 per unit, this rate applies across all activity levels. Variable costs change in total directly in proportion to activity level changes.

This flexible budget variance analysis will help you become more accurate year after year with respect to your budget. While straightforward, it has limitations because it doesn’t account for indirect or overhead costs. However, it serves as a foundational tool for small businesses or organizations with fewer variable cost components.

• For instance, fixed rent cost remains constant only up to a certain production capacity; exceeding that might require a larger facility, changing the fixed cost.
• Forecasting tools can integrate with various data sources, like Xero Accounting, and spreadsheets, to collect accurate data on activity levels and costs.
• You can also study the monthly adjustments and notes to more accurately plan for future costs.
• A flexible budget can be found suitable when business conditions are constantly changing.
• The next step is determining the variable cost per unit for each expense category.

Though time-intensive to prepare, an advanced flexible budget provides the most precise insight into financial performance. It is best suited for large organizations or businesses operating in highly volatile environments. Tools like Limelight FP&A are indispensable for managing the complexity of advanced flexible budgets. Once you have how your variable costs vary as business activity changes, you will now need to create your budget. For instance, when companies do not have the final figures on their activity levels, managers can approve a budget as a proportion of revenues or business activity so the business can move forward. A static budget helps to monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance.

For instance, increasing production beyond current capacity might necessitate acquiring new machinery, altering total fixed costs. Identifying appropriate activity measures is also important; these are the drivers that cause costs to be incurred or revenues to be generated. Common activity measures include units produced, direct labor hours, machine hours, or sales revenue. A key distinction between a flexible budget and a static budget is how they account for changes in business activity. A static budget is prepared for only one planned level of activity and does not change, regardless of the actual volume of sales or production achieved. If actual activity deviates from the initial plan, the static budget becomes less useful for performance evaluation.

With an intuitive platform, our solutions make it easier to implement flexible budgeting, integrating real-time data to provide accurate insights. This dynamic model adjusts to changes in elements such as production and sales, ensuring that the numbers consistently reflect operational reality and not just initial static projections. Switching to flexible budgets helps you keep your costs proportional to revenue. Examples of variable costs include raw materials used in production, shipping costs, and packaging.

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. Also, temporary staff or additional employees needed for overtime during busy times are best budgeted using a flexible budget versus a static one. Within an organization, static budgets are often used by accountants and chief financial officers (CFOs)–providing them with financial control.

A flexible budget also allows for more creativity with how you spend money and saves time by not requiring constant monitoring of your spending habits and trends. Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula. For example, a company may budget for electricity and supplies costs for operating a machine based on the number of hours it’s in operations.

Traditional budgeting uses a single, predetermined activity level, but business operations often fluctuate. Flexible budgets offer a dynamic framework for financial management, adapting to these changes. This adaptable budgeting helps maintain financial control and accurately assess performance when actual activity levels deviate from initial forecasts.