However, this comparison may be like comparing apples to oranges because variable costs should follow production, which should follow sales. 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. A flexible budget flexible budget meaning created each period allows for a comparison of apples to apples because it will calculate budgeted costs based on the actual sales activity. A flexible budget is an adaptable financial planning tool that allows companies to adjust projected expenses and revenues in response to changes in activity levels or other relevant factors.

Conversely, if revenue didn’t at least meet the targets set in the static budget, or if actual costs exceeded the pre-established limits, the result would lead to lower profits. The static budget is intended to be fixed and unchanging for the duration of the period, regardless of fluctuations that may affect outcomes. 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.

What Does Flexible Budget Mean?

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. 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. If the factory has to use more machine hours one month, its budget should logically increase.

Over time, though, your actual production, sales, and revenue will change. These changes can be due to variations such as changing inventory costs, supply chain concerns, and market conditions. You would then take your static, or master, budget and adjust the numbers based on your actual revenue. It has been “flexed,” or adjusted, based on your real production levels. For example, let’s say a company had a static budget for sales commissions whereby the company’s management allocated $50,000 to pay the sales staff a commission.

Budget with Varying Levels of Production

A flexible intermediate budget considers changes in costs based on such other activity measures. Thus, it provides a more accurate reflection of how costs and revenues change with fluctuations in activity. A static budget helps to monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance. By keeping each department or division within budget, companies can remain on track with their long-term financial goals. A static budget serves as a guide or map for the overall direction of the company. The flexible budget shows an even higher unfavorable variance than the static budget.

Finmark is everything you need to build an accurate, customized financial model. 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.

Variance Analyses: Tale of Two Coffee Shops

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. The first column lists the sales and expense categories for the company. The second column lists the variable costs as a percentage or unit rate and the total fixed costs. The next three columns list different levels of output and the changes in variable costs based on the increased or decreased sales.

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. The more sophisticated relative of the static budget model, a flexible budget allows for change, and as we’ve said – business can be unpredictable. 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. Accountants enter actual activity measures into the flexible budget at the end of the accounting period.

What Are Flexible Budgets? 4 Best Practices

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. The columns would continue below with fixed and variable expenses, allowing you to see how your net profit changes based on changes in actual production and revenue. Once you identify fixed and variable costs, separate them on your budget sheet. Under a flexible budget the budgeted amount of manufacturing overhead will increase if the company produces more units than planned.

The model is designed to match actual expenses to expected expenses, not to compare revenue levels. There is no way to highlight whether actual revenues are above or below expectations. 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. This allows for budget adjustments to occur in real-time, taking into account external factors.

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. All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound. This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue. A flexible budget, while much more time-intensive to create and maintain, offers an incredibly precise picture of your company’s performance. Due to the ability to make real-time adjustments, the results present great detail and accuracy at the end of the year. We’ve previously covered the five different types of budget models that businesses can choose from.