According to this data, the monthly flexible budget would be $35,000 + $8 per MH. The company also knows that the depreciation, supervision, and other fixed costs come to about $35,000 per month. A flexible budget is a budget or financial plan that varies according to the company’s needs. They made it flexible because the specific company’s or department’s needs do not remain static. 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.
By incorporating these changes into the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity. In theory, a flexible budget is not difficult to develop since the variable costs change with production and the fixed costs remain the same. 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. In the original budget, making 100,000 units resulted in total variable costs of $130,000. Dividing total cost of each category by the budgeted production level results in variable cost per unit of $0.50 for indirect materials, $0.40 for indirect labor, and $0.40 for utilities.
Its production equipment operates, on average, between 3,500 and 6,500 hours per month. After understanding your current spending patterns, consider the following five personal budget ideas to find the best fit for you. Let’s face it – business moves fast, and we have to be flexible for what is thrown at us.
4 Prepare Flexible Budgets
Some costs are variable — they change in response to activity levels — while other costs are fixed and remain the same. For example, direct materials are variable costs because the more goods you make, the more materials you need. For example, your master budget may have assumed that you’d produce 5,000 units; however, you actually produce 5,100 units. The flexible budget rearranges the master budget to reflect this new number, making all the appropriate adjustments to sales and expenses based on the unexpected change in volume.
- Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range.
- It helps to provide accurate forecasts without using theoretical data since they are based on what occurred.
- Using a debit card with the no-budget budget method is best since it connects directly to your checking account and automatically updates your balance.
- However, this approach ignores changes to other costs that do not change in accordance with small revenue variations.
Since there’s less room for error with the zero-based budget, it’s generally a better option for someone used to budgeting. Even then, keeping extra cash in your checking account as a buffer is a good idea. Keep all receipts for one to two months, sorting them into categories like food, shopping, household and entertainment expenses. Alternatively, you can view your checking and credit card activity online — some credit cards even split your charges into categories to help you understand how you spend your money.
Create a Free Account and Ask Any Financial Question
It begins with a static framework built from the costs that are not anticipated to change throughout the year. Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance. Steve made the elementary mistake of treating variable costs as fixed. After all, portions of overhead, such as indirect materials, appear to be variable costs. If Skate increased production from 100,000 units to 125,000 units, these variable costs should also increase.
Static budgets are used by accountants, finance professionals, and the management teams of companies looking to gauge the financial performance of a company over time. A company makes a budget for the smallest time period possible so that management can find and adjust problems to minimize their impact on the business. Everything starts with the estimated sales, but what happens if the sales are more or less than expected? What adjustments does a company have to make in order to compare the actual numbers to budgeted numbers when evaluating results?
Home Run Budget: 120% Capacity
When using a static budget, some managers use it as a target for expenses, costs, and revenue while others use a static budget to forecast the company’s numbers. This budgeting method is best for people who have a set income each month or can reasonably estimate their monthly income. After calculating your monthly income, subtract all your monthly expenses proprietary ratio explanation formula example and interpretation and savings, making sure the final result is zero. 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. After you adjust for the change in production level, Skate’s variance is suddenly favorable.
If it used a flexible budget, the fixed portion of the cost of goods sold would still be $1 million, but the variable portion would drop to $2.7 million, since it is always 30% of revenues. The result is that a flexible budget yields a budgeted cost of goods sold of $3.7 million at a $9 million revenue level, rather than the $4 million that would be listed in a static budget. Within an organization, static budgets are often used by accountants and chief financial officers (CFOs)–providing them with financial control. The static budget serves as a mechanism to prevent overspending and match expenses–or outgoing payments–with incoming revenue from sales. In short, a well-managed static budget is a cash flow planning tool for companies. Proper cash flow management helps ensure companies have the cash available in the event a situation arises where cash is needed, such as a breakdown in equipment or additional employees needed for overtime.
How to Implement a Flexible Budget
Consider using a budgeting app and automating your debt payments to make the process easier. Doing this can help maintain your motivation to keep fine-tuning your budgeting skills. And if you need help with debt repayment strategies, consider the debt snowball or debt avalanche method. Even if you pick the right financial budget, it can take a few months to get used to the system, especially if you are new to budgeting.
He has taught accounting at the college level for 17 years and runs the Accountinator website at , which gives practical accounting advice to entrepreneurs. 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. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
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, if your business predicts that five units will sell per month at $5 each, you can expect a revenue of $25 a month. In other words, comparing the $60,000 actual cost of making 125,000 units to the $50,000 budgeted cost of making just 100,000 units makes no sense. Consider Kira, president of the fictional Skate Company, which manufactures roller skates. Additionally, at 50% capacity, working the product costs $180 per unit and it is sold at $200 per unit.
Understanding a Static Budget
By the fourth 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. Once you have created your flexible budget, at the end of the accounting period you will want to compare the flexible budget totals against actuals. This comparison allows you to make any future adjustments based on the flexible budget variance indicated in the comparison. The flexible budget example below displays both the original static budget amount as well as a flexible budget based on increased production levels.
With a flexible budget, it’s easy to show that while costs for a month might have been much higher than budgeted, so were sales – justifying the increase. You can also study the monthly adjustments and notes to more accurately plan for future costs. For Skate, an analysis indicates that indirect materials, indirect labor, and utilities are variable costs. On the other hand, supervisory salaries, rent, and depreciation are fixed. Steve recomputes variable costs with the assumption that the company makes 125,000 units.