If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served? Similar scenarios exist with merchandising and manufacturing companies. To effectively evaluate the restaurant’s performance in controlling costs, management must use a budget prepared for the actual level of activity.

As traffic to the company’s site increases, hosting costs likewise increase. That’s why SaaS companies might make a connection between an AWS budget line item and the assumption for customer growth. 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. Expenses such as rent, management salaries, and marketing costs remain static and do not change based on production. For example, Figure 7.24 shows a static quarterly budget for 1,500 trainers sold by Big Bad Bikes.

For Example, A company has prepared a flexible budget and expects an output of 500 units. Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. It’s most common to update forecasted line items in a flexible budget following a monthly review of total costs and top-line growth. With a flexible budget model, if your demand suddenly triples, your cost of goods sold (COGS) can be adjusted by a predetermined percentage ensuring that you have the cash to fill these orders.

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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. Flexible budgets calculate, for example, different levels of expenditure for variable costs. Subsequently, the budget varies, depending on activity levels that the company experiences. The flexible budget uses the same selling price and cost assumptions as the original budget.

• However, if actual performance in a given month or quarter is different from the planned amount, it is difficult to determine whether costs were controlled.
• A flexible budget provides budgeted data for different levels of activity.
• Both static and flexible budgets are designed to estimate future revenues and expenses.
• The budget report is used by management to identify the sales or expenses whose amounts are not what were expected so management can find out why the variances occurred.
• Only then is it possible to issue financial statements that contain budget versus actual information, which delays the issuance of financial statements.
• Revenue and cost needs to be compared monthly and adjustments or notes should be made.

This does not always happen but is why flexible budgets are important for giving management an indication of what questions need to be asked. Your flexible budget would then look at revenue, based on both units sold and sales price. For example, your flexible budget may have three columns that show the number of units sold, the sales price, and total revenue. Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes.

Pandemic Budget: 70% Capacity

Flexible budgets work by taking the pressure off to predict future happenings. More often than not, our budgets should be just as flexible as we are. If you do find yourself in the market for accounting software for your small business, be sure to check out The Ascent’s accounting software reviews and find an application that is a good fit for your business needs. NetSuite has packaged the experience gained from tens of thousands of worldwide deployments over two decades into a set of leading practices that pave a clear path to success and are proven to deliver rapid business value.

A sophisticated flexible budget will change the proportions for these expenditures if the measurements they are based on exceed their target ranges. 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. When using a static budget, a company or organization can track where the money is being spent, how much revenue is coming in, and help stay on track with its financial goals. In conclusion, the budget that companies can prepare for multiple output levels is a Flexible Budget. Practically, managers widely use this type of budget as it is the most realistic one. It analyses the costs with respect to the variations in the output levels.

Favorable variances are usually positive amounts, and unfavorable variances are usually negative amounts. Some textbooks show budget reports with “F” for favorable and “U” for unfavorable after the variances to further highlight the type of variance being reported. Revenue variance is the difference between what revenue should have been for the actual production activity and what the actual revenue you take in is. It may be favorable (higher than it should have been for actual production activity) or unfavorable (lower than it should have been). 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 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.

Doesn’t Apply to All Line Items

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. 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. This approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels.

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A company wants to prepare a budget based on a scheduled activity level of 70% of the production capacity, where the number of units designed is 7000. The variable costs and fixed costs are $7,000 and $10,000, respectively. Flexible budgets are especially helpful in environments where costs are closely aligned with the level of business activity.

While this isn’t a reason to avoid flexible budgeting altogether, it’s good to keep in mind as you consider how and when to implement this kind of budgeting strategy. If your company regularly conducts a flux analysis, syncing this process with your flexible budget creation can help save time. A flexible budget often uses a percentage breast cancer 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. It begins with a static framework built from the costs that are not anticipated to change throughout the year.

With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. 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. Let’s face it  – business moves fast, and we have to be flexible for what is thrown at us. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. If the factory has to use more machine hours one month, its budget should logically increase. Conversely, if it uses them for fewer hours, its budget should reflect that decline.