These are added to the fixed costs of $12,500 to get the flexible budget amount of $24,750. The flexible budget uses the same selling price and cost assumptions as the original budget. The variable amounts are recalculated using the actual level of activity, which in the case of the income statement is sales units.
Flexible budgets offer close monitoring of expenses versus revenue, and they allow for the opportunity to test things out and see what might work and what won’t without rigid financial constraints. For example, Figure 7.24 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes. Flexible budgeting is an important tool for most small businesses.
Categories of Expenses in a Flexible Budget
At its simplest, the flexible budget alters those expenses that vary directly with revenues. There is typically a percentage built into the model that is multiplied by actual revenues to arrive at what expenses should be at a stated revenue level. In the case of the cost of goods sold, a cost per unit may be used, rather than a percentage of sales.
A flexible budget is usually designed to predict effects of changes in volume and how that affects revenues and expenses. In order to accurately predict the changes in costs, management has to identify the fixed costs and the variable costs. Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases. 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%).
flexible budget definition
However, planning to meet an organization’s goals can be very difficult if there are not many variable costs, if the cash inflows are relatively fixed, and if the fixed costs are high. For example, this article shows some large U.S. cities are faced with complicated budgets because of high fixed costs. ABC Company has a budget of $10 million in revenues and a $4 million cost of goods sold.
The Finmark Blog is here to educate founders on key financial metrics, startup best practices, and everything else to give you the confidence to drive your business forward. Imagine your product goes viral on social media and flexible budget meaning gains unexpected popularity overnight, now there is a demand for 20 units next month, which would cost $20 to make. Now, let’s assume that it costs one dollar to make each unit of product, so you budget $5 a month for this.
Pandemic Budget: 70% Capacity
Companies must involve experts to make accurate budgets, ensuring there is less scope for error and improving variance analysis. If such predictive planning is not possible, there will be a disparity between the static budget and actual results. In contrast, a flexible budget might base its marketing expenses on a percentage of overall sales for the period. That would mean the budget would fluctuate along with the company’s performance and real costs.
- A flexible budget adjusts based on changes in actual revenue or other activities.
- Flexible budgets calculate, for example, different levels of expenditure for variable costs.
- Over time, though, your actual production, sales, and revenue will change.
- The budget shown in Figure 7.25 illustrates the payment of interest and contains information helpful to management when determining which items should be produced if production capacity is limited.
- They work well for evaluating performance when the planned level of activity is the same as the actual level of activity, or when the budget report is prepared for fixed costs.