a flexible budget is a budget prepared for a different level of volume than that which was originally anticipated.
What is a Flexible Budget?
A flexible budget is a budget that is designed to change in accordance with the level of activity or volume that is being measured. These budgets are considered flexible because they can be adjusted by management as and when volume changes. Essentially, a flexible budget allows companies to make changes to their budgets mid-term to meet unexpected changes in demand, costs or other factors.
The purpose of a flexible budget is to give a company a more accurate picture of their actual performance. By comparing actual results to what would have been spent at different levels of activity, a flexible budget can calculate variances and help identify potential problem areas. Traditional budgets are often inflexible in nature and assume that output volume will remain constant throughout the period. This type of budgeting can lead to inaccurate data, overspending and missed opportunities.
How is a Flexible Budget Prepared?
To prepare a flexible budget, a company first needs to identify the relevant cost drivers for each of its operations. For example, the cost of production of a product may depend on the number of units that are produced or the number of hours of labour that are required. Similarly, variable overheads such as marketing expenses may depend on the number of units sold.
Once the cost drivers have been identified, the company then needs to create a budget that reflects the costs associated with different levels of activity. Typically, these budgets are split into different levels of output or activity, and then associated with costs on a per-unit basis.
For example, a manufacturing firm may budget for production at 80%, 90%, and 100% of capacity. They would then create a budget that reflects what their total costs would be at each level of production. This includes both fixed and variable costs, with the variable costs changing significantly depending on the level of output.
Why is a Flexible Budget Important?
A flexible budget has several benefits for a company. Firstly, it enables a company to plan for different scenarios in order to make better decisions. Rather than assuming that the level of output will remain constant, a flexible budget takes into account the possibility of changes in activity levels. This can help a company to identify potential problem areas in advance, and to make better decisions on how to allocate resources.
Secondly, a flexible budget allows a company to adjust spending in relation to changes in demand. This enables a company to have greater control over their costs, as they can avoid overspending if demand falls. Additionally, a flexible budget can help identify any variances between actual spending and what would have been spent at different levels of output. This can help a company to identify areas where they may need to make changes in order to improve efficiency.
Thirdly, a flexible budget can help a company to set realistic targets for performance. By reflecting what would have been spent at different levels of activity, a flexible budget can provide a more realistic estimate of actual costs. This can help companies to identify areas for potential cost savings, while still maintaining the quality of their products or services.
In conclusion, a flexible budget is an important tool for companies that want to be able to adapt to changing market conditions. By allowing companies to adjust their budgets based on changing circumstances, a flexible budget can help improve decision-making and resource allocation. This can lead to improved efficiency, reduced costs, and better performance overall.