Flexible Budget Overview
A flexible budget calculates different expenditure levels for variable costs, depending upon changes in actual revenue. The result is a budget that varies, depending on the activity levels experienced. You input the actual revenues or other activity measures into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs.
The budget is then compared to actual information for control purposes. The steps needed to construct a flexible budget are:
Identify all fixed costs and segregate them in the budget model.
Determine the extent to which all variable costs change as activity measures change.
Create the budget model, where fixed costs are “hard coded” into the model, and variable costs are stated as a percentage of the relevant activity measures or as a cost per unit of activity measure.
Enter actual activity measures into the model after an accounting period has been completed. This updates the variable costs in the flexible budget.
Enter the resulting flexible budget for the completed period into the accounting system for comparison to actual expenses.
This approach varies from the more common static budget, which contains nothing but fixed amounts that do not vary with actual revenue levels. Budget versus actual reports under a flexible budget tend to yield variances that are much more relevant than those generated under a static budget, since both the budgeted and actual expenses are based on the same activity measure. This means that the variances will likely be smaller than under a static budget, and will also be highly actionable.
You can create a flexible budget that ranges in level of sophistication. Here are several variations on the concept:
Basic flexible budget. At its simplest, the flexible budget alters those expenses that vary directly with revenues. There is typically a percentage built into the model that is multiplied by actual revenues to arrive at what expenses should be at a stated revenue level. In the case of the cost of goods sold, a cost per unit may be used, rather than a percentage of sales.
Intermediate flexible budget. Some expenditures vary with other activity measures than revenue. For example, telephone expenses may vary with changes in headcount. If so, you can integrate these other activity measures into the flexible budget model.
Advanced flexible budget. Expenditures may only vary within certain ranges of revenue or other activities; outside of those ranges, a different proportion of expenditures may apply. A sophisticated flexible budget will change the proportions for these expenditures if the measurements they are based on exceed their target ranges.
In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity.