In finance and business, a budget is a financial plan for future planning activities. It can be a personal plan, or it can be a vision of the future of the business. From there, they provide perfect solutions for life.

Specifically, building a budget plan is to estimate the revenues and expenditures for a business project. From there, use financial resources effectively and balance the use of money to bring profit as well as develop the business.

On the other hand, through the budget plan, you also need to consider a number of issues that are: How does the business plan to use capital? Is business spending commensurate with activity? Does the budget comply with regulations on capital use? How much do operating costs account for in the estimate? Which factors will directly and indirectly affect the business budget?

Therefore, in order to plan the budget as closely as possible to the actual level of business activities, people use flexible budgets.

What is a flexible budget?

A flexible budget is a budget that allows costs to be adjusted to change with changes in the volume of output. For example, if the costs associated with operating 50% of plant capacity are different from the costs of operating 70% or 100% of capacity. Budgets must be allowed to vary with capacity utilization by distinguishing between fixed and variable costs, as well as their relationship to output.

Therefore, preparing a flexible budget requires an understanding of how a company’s revenue and expenses are affected when operations change over a specific period of time based on overall control and performance reports. From this understanding, formulas are created to capture the cost and revenue behavior in the main budget. Before costs can be added, they must be correctly classified as variable or fixed.

Types of flexible budgets

Depending on the requirements of the business, a corporation can create a variety of flexible budgets, ranging from simple to complex. The three types of flexible budgets that are most frequently employed are as follows:

1. Basic flexible budget

This type of budget adapts to changes in a company’s expenses that are directly related to those changes in revenue. A simple budget can include a percentage that changes depending on revenue. Typically, this type of budget is used to indicate the cost per unit or a proportion of sales.

2. Intermediate flexible budget

An intermediate flexible budget  accounts for costs that exceed a business’s revenue. This budget typically incorporates activity-related expenses instead of or in addition to revenue. For instance, a company’s insurance policy rates may change depending on how many employees it has and may rise if it recruits more.

3. Advanced flexible budget

This type of budget considers the ranges and variations in spending based on each component of a company’s budget. An advanced flexible budget will change based on the actual costs for each section.

Why is a flexible budget important?

The main importance of a flexible budget is that it reflects appropriate spending at different levels of output. Expenditure is established through an appropriate flexible budget that compares actual expenditure incurred with the applicable budget level for that particular level of activity achieved.

– Calculate operational reality and streamline profit planning and control functions. It gives a balanced perspective on comparison. When the flexible budget is prepared, the actual costs at the actual activity are compared with the flexible budget costs.

– Flexible budgeting is useful for budget control purposes because it corresponds to changes in activity levels.

– Very useful in evaluating the performance of department heads, as their performance can be assessed in relation to the level of performance achieved by the organization.

How to calculate flexible budget?

To find a flexible budget for your organization, let’s follow the steps listed below:

1. Determine fixed costs

The first step in building a flexible budget is to identify fixed costs, which are costs that will remain constant regardless of how well a company performs. Some examples of fixed costs are as follows:

Rent, mortgage, and loan payments are generally consistent from month to month.

Salaries: Employees’ yearly pay is a constant expense because each payment contains the same amount of money.

Insurance: If you’re constantly charged the same amount, insurance payments can be a fixed cost.

 2.  Identify variable costs

After you’ve determined your fixed costs, you may determine your variable costs, which may vary depending on the amount of your production or service. The following are some examples of variable costs:

Bills for utilities: Depending on how much energy you consume, your office’s utility bills may rise or fall.

Part-time salaries: If part-time employees do not work the same number of hours each pay period, their compensation may change.

Supplies: Office supplies such as coffee, paper, and printer ink may not be the same price each time you buy them.

3. Determine how much your variable costs change

Once you’ve sorted out fixed costs and variable costs, you can calculate how much your variable costs change each month. There are several ways in which you can calculate the variable cost of a job:

A common calculation is the cost per unit of production. Divide the variable cost by the number of units to get the variable cost per unit. Next, do the same calculation with fixed costs.

For example, if a company spends $40,000 to produce 1,000 products, this is a variable cost based on the number of completed products. You may calculate the price per unit by multiplying $40,000 by 1000, which equals $40, implying that a single product costs $40 to make. You can broaden your budget for different levels of output by using per-unit pricing.

You may calculate the overall variable cost using this information. Multiply the total production by the variable cost of each unit produced to arrive at this result. For example, if 1,000 units of a product are produced and the variable cost per unit is $25, the total variable cost is $25,000.

You can also calculate average variable costs unrelated to production. For example, if company utilities cost $350, $300, and $250 in a quarter, you can add the costs together and divide them by the number of months. In this case, $900 divided by three is $300, so the average variable cost for utilities is $300 per month.

4. Create a flexible budget

You can include your fixed and variable costs, as well as the amount by which they vary, in your budget.

You can create your budget in a variety of ways. Fixed and variable costs can be entered as set numbers in your budget, with a separate column for variance. You might also use percentages to show the portion of the budget that variable costs are expected to consume. Another option is to create columns in the budget that reflect variable expenses for certain benchmarks, such as the amount of revenue you earn. To finish the budget, include totals for fixed expenses, variable costs, and total overhead costs.

General formula:

Flexible budget = Fixed cost + Activity level * Unit operating cost

Whatever way you choose to represent your numbers, make sure your budget is understandable to an outside source in case you need this budget for accounting or auditing purposes.

Once your budget has been used, update it periodically with any changes to the variable cost percentages to make them more accurate. A flexible budget should be reviewed at least once per quarter or whenever the business suffers major budgetary changes. This might help you continue to make informed workplace expenditure decisions.

Conclusion

In summary, flexible budgeting is useful for budget control purposes because it corresponds to changes in activity level. It is useful in evaluating the performance, controlling the optimal operating costs of the managers.