Flexible Budgets for Small Business Explained in Less Than 5 Minutes

So as headcount increases, the cost of benefits also increases according to the per-employee assumption. The flexible budget will show different possibilities for variable expenses and revenue. Variable costs can include marketing and sales, and may also include the cost of materials, number of sales, and shipping costs.

  • Revenue and cost needs to be compared monthly and adjustments or notes should be made.
  • Using the following information, prepare a flexible budget for the production of 80% and 100% activity.
  • The first column lists the sales and expense categories for the company.
  • It also knows that other costs are fixed costs of approximately $40,000 per month.
  • A static budget based on planned outputs and inputs for each of a company’s divisions can help management track revenue, expenses, and cash flow needs.

More than likely, specific sections of your balance sheet or income statements could benefit from a bit more flexibility. Flexible budgets are usually prepared at each business analysis period (either monthly or quarterly), rather than in advance. An alternative is to run a high-level flex budget as a pilot test to see how useful the concept is, and then expand the model as necessary. Flexible budgets do not fix variances, they help to better plan for the future. Revenue is still calculated at month end so costs cannot be retroactively adjusted.

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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 https://kelleysbookkeeping.com/ 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.

Flexible budgets are best used for startups that have a number of variables such as manufacturing, and others that have revenue based on seasonality, as costs are directly impacted by demand. Flexible budgets are dynamic systems which allow for expansion and contraction in real time. They take into account that a business is an organic, growing system and that life is not predictable. https://business-accounting.net/ Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed for future periods. We’ve previously covered the five different types of budget models that businesses can choose from. The flexible budget offers the most customizable experience, allowing it to be easily adopted by many different businesses.

  • This way, budget adjustments can happen in real time while taking into account external factors like economic shifts and rising competition.
  • Accountants enter actual activity measures into the flexible budget at the end of the accounting period.
  • Flexible budgets take time to maintain, with routine monthly reviews and edits.
  • With flexible budgets, it’s easy to make updates to revenue and activity figures that haven’t been finalized.
  • It is unlike the static or traditional budget, which cannot be changed once created.
  • Flexible budgets come with advantages like their usability in variable cost environments, their detailed picture of performance, and their overall efficiency for budgeting teams.

The budget shown in Figure 10.27 illustrates the payment of interest and contains information helpful to management when determining which items should be produced if production capacity is limited. While flexible budgets are often used for manufacturing overhead, they’re also pretty common for SaaS businesses. If a SaaS company is forecasting its cost of benefits, it might tie the budget line item to its headcount forecast.

Understanding a Static Budget

The accuracy of the budget largely depends upon the efficient classification of the costs. Its production equipment operates, on average, between 3,500 and 6,500 hours per month. As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration. 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. 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.

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Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance. The ability to provide flexible budgets can be critical in new or changing businesses where the accuracy of estimating sales or usage my not be strong. For example, organizations are often reporting their sustainability efforts and may have some products that require more electricity than other products. The reporting of the energy per unit of output has sometimes been in error and can mislead management into making changes that may or may not help the company. Suddenly, there is only one company to meet demand for widgets, resulting in actual sales of 200 units per month. The actual revenue the widget company is taking in has doubled—but the production costs would also go up.

Thereafter, prepare a flexible budget for single or multiple activity levels. 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.

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. Big Bad Bikes used the flexible budget concept to develop a budget based on its expectation that production levels will vary by quarter. By the fourth https://quick-bookkeeping.net/ quarter, sales are expected to be strong enough to pay back the financing from earlier in the year. 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.

4 Prepare Flexible Budgets

A flexible budget on the other hand would allow management to adjust their expectations in the budget for both changes in costs and revenue that would occur from the loss of the potential client. 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.

For costs that vary with volume or activity, the flexible budget will flex because the budget will include a variable rate per unit of activity instead of one fixed total amount. In short, the flexible budget is a more useful tool when measuring a manager’s efficiency. Instead, the hope is that patterns will be observed making future cost planning easier and more accurate. In addition, a flexible budget can successfully justify increases in costs when compared to actual income. Among all, the one closer to the actual activity is to be considered.

Regardless of the total sales volume–whether it was $100,000 or $1,000,000–the commissions per employee would be divided by the $50,000 static-budget amount. However, a flexible budget allows managers to assign a percentage of sales in calculating the sales commissions. The management might assign a 7% commission for the total sales volume generated. Although with the flexible budget, costs would rise as sales commissions increased, so too would revenue from the additional sales generated. Flexible budgets have the ability to constantly restructure themselves around changes in activity.

Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

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