Static Budget Definition, Limitations, vs a Flexible Budget

Flexible budgeting is a dynamic budgeting model that allows you to adjust to changes in costs and revenue in real time. But don’t get caught up in comparing this type of budget to other types. What’s more  important is to apply the principles to certain parts of your budget. 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. Now let’s illustrate the flexible budget by using different levels of volume. If 5,000 machine hours were necessary for the month of January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH).

According to this data, the monthly flexible budget would be $35,000 + $8 per MH. Flexible budgeting can also tie into anything related to headcount (like employee benefits and salaries). A flexible budget will show the variance in both revenue and spending. Many costs are not fully variable, instead having a fixed cost component that must be derived and then included in the flex budget formula. 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.

Its estimations of sales and sales price will likely change as the product takes hold and customers purchase it. Big Bad Bikes developed a flexible budget that shows the change in income and expenses as the number of units changes. It also looked at the effect a change in price would have if the number of units remained the same. The expenses that do not change are the fixed expenses, as shown in Figure 7.23. The expenses that do not change are the fixed expenses, as shown in Figure 10.25. 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.

Additionally, at 50% capacity, working the product costs $180 per unit and it is sold at $200 per unit. Semi-variable expenses remain constant between 45% and 65% capacity, increasing by 10% between 65% and 80% capacity, and by 20% between 80% and 100% capacity. You should assume that the fixed expenses remain constant for all levels of production. Using the following information, prepare a flexible budget for the production of 80% and 100% activity. A static budget stays at a single amount regardless of how much activity there is. Spending variance is the difference between what you should have spent at your actual production level and what you did spend.

  • If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance.
  • A flexible budget often uses a percentage of your projected revenue to account for variable costs rather than assigning a hard numerical value to everything.
  • So if the initial static budget called for 25% to be spent on marketing, the flexible budget will maintain that same percentage for marketing whether the budget increases or decreases.
  • For example, a restaurant may serve 100, 150, or 300 customers an evening.

If the machine hours in February are 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). The more sophisticated relative of the static budget model, a flexible budget allows for change, and as we’ve said – business can be unpredictable.

Pandemic Budget: 70% Capacity

Typically, the machine hours are between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. If, however, the cost was identified as a fixed cost, no changes are made in the budgeted amount when the flexible budget is prepared. Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range.

  • Thus, if sales differ from what is budgeted, then comparing actual costs to budgeted costs may not provide a clear indicator of how well the company is meeting its targets.
  • If production is higher than planned and has been increased to meet the increased sales, expenses will be over budget.
  • For SaaS companies, flexible budgeting relates more to the cost of revenue — the actual costs for creating and delivering a product/service to customers.

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. If the last few years have taught SaaS companies anything, it’s that sometimes uncertainty is the only certainty there is. Recent years have illuminated how unpredictable the marketplace can be — making it increasingly challenging to create accurate budgets and execute an effective budget analysis on a recurring basis.

Intermediate Flexible Budget

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. With flexible budgets, it’s easy to make updates to revenue and activity figures that haven’t been finalized. Because of these seamless workflows (and because of the inherent adaptability), flexible budgets give way to more efficiency than their fixed budget counterparts. Flexible budgets are one way companies deal with different levels of activity.

The flexible budget adapts

Subsequently, the budget varies, depending on activity levels that the company experiences. A fixed budget is one that stays the same and doesn’t change based on variable costs. Flexible budgets change based on fluctuations with variable costs and have the ability to expand or contract in real time. This approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels. This means that the variances will likely be smaller than under a static budget, and will also be highly actionable.

Flexible Budgets

Total net income changes as the amount for each line on the income statement changes. 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 need to build an accurate, customized financial model. 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. They allow managers to predict the effect that changes will have on their company’s income statement and balance sheet while still being able to reflect actual figures. It helps to provide accurate forecasts without using theoretical data since they are based on what occurred.

Definition and Examples of a Flexible Budget

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. Flexible budgeting can be used to more easily update a budget for which revenue or other activity figures have not yet been finalized. Under this approach, managers give their approval for all fixed expenses, as well as variable expenses as a proportion of revenues or other activity measures.

What Is a Static Budget?

The variable costs and fixed costs are $7,000 and $10,000, respectively. Most flexible budgets use a percentage of projected revenue to account for variable costs rather than assigning a rigid numerical value at the start. Flexible budgets are especially helpful in environments where costs are closely aligned with the level of business activity. SaaS businesses typically work with costs like hosting fees and site development, so when website traffic starts to increase, so do those hosting costs. The first column lists the sales and expense categories for the company.

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