To account for actual sales and expenses differing from budgeted sales and expenses, companies will often create flexible budgets to allow budgets to fluctuate with future demand. A flexible budget flexes the static budget for each anticipated level of production. This flexibility allows management to estimate what the budgeted numbers would look like at various levels of sales. Flexible budgets are prepared at the end of each analysis period (usually 13 things bookkeepers do for small businesses monthly), rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level. Flexible budgets are prepared at each analysis period (usually monthly), rather than in advance, since the idea is to compare the operating income to the expenses deemed appropriate at the actual production level. The original budget assumed 17,000 Pickup Trucks would be sold at $15 each.
Advantages of Flexible Budgeting
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Example – Lobster Instant Noodles
In short, a flexible budget requires extra time to construct, delays the issuance of financial statements, does not measure revenue variances, and may not be applicable under certain budget models. The https://www.kelleysbookkeeping.com/cost-benefit-principle/ contribution margin ratio (CMR) is a key component of the flexible budget calculation. It shows the percentage of each sales dollar that goes towards covering variable costs and generating profit.
Chapter 6: Budgeting for Operations
To do this, you’ll need to make some assumptions regarding future sales volumes based on historical data or forecasts. Now that we know how to create the flexible budget, the next step is to understand the variance analysis – the comparison between the flexible budget and the business’s actual performance. Though the flex budget is a good tool, it can be difficult to https://www.kelleysbookkeeping.com/ formulate and administer. One problem with its formulation is that many costs are not fully variable, instead having a fixed cost component that must be calculated and included in the budget formula. Also, a great deal of time can be spent developing cost formulas, which is more time than the typical budgeting staff has available in the midst of the budget process.
- Actual revenues or other activity measures are entered into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs.
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- If production is higher than planned and has been increased to meet the increased sales, expenses will be over budget.
- In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget.
Flexible Budgets and Sustainability
The lack of a variance indicates that costs in total (materials, labor, and overhead) were the same as planned. The first step in calculating a flexible budget is to identify the variable and fixed costs in your organization. Variable costs are those that change directly with changes in production or sales volume, while fixed costs remain constant regardless of the volume. For each sales volume level (low, medium, and high), calculate the respective variable costs and add them to the fixed costs.
Companies develop a budget based on their expectations for their most likely level of sales and expenses. Often, a company can expect that their production and sales volume will vary from budget period to budget period. They can use their various expected levels of production to create a flexible budget that includes these different levels of production.
A flexible budget can be created that ranges in level of sophistication. In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity. The flexible budget variance isolates the difference between actual results and budget projections based on larger than expected or less than expected sales price (for revenues) and costs (for expenses). 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.
The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250. Actual expenses are lower because the income before income taxes was lower. And so, the difference between our contribution margin statement and the master budget is the effect of sales volume versus production volume—and the effect of both beginning and ending inventory. Leed Company’s manufacturing overhead cost budget at 70% capacity is shown below. Leed can produce 25,000 units in a 3 month period or a quarter, which represents 100% of capacity. Some expenditures vary with other activity measures than revenue.
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. The advantage to a flexible budget is we can create a budget based on the ACTUAL level of production to give us a clearer picture of our results by comparing the flexible budget to actual results. This analysis would compare the actual level of activity so volume variances are not a factor and management can focus on the cost variances only. We can calculate the flexible budget for any level of activity using these figures. Leed Company prepares a flexible budget for 70%, 80%, 90% and 100% capacity.