Definition of Flexible Budget – Preparation of a good budget plan will help the management team easily achieve organizational and business plans and goals. Armed with a good budget, management can also estimate costs and productivity levels, to forecast future fluctuations in sales. One of the budget plans that can adapt to future fluctuations is a flexible budget.
A flexible budget is a budget design method that can adjust or adapt to changes in the level or volume of activity. Flexible budgets are better suited for activity types with variable volume than static budgets.
Flexible budgets are more effective because they measure costs down to variable costs per unit. Flexible budgets can also measure how effective a manager is. This is because a flexible budget can adjust spending based on activity level or volume, unlike a static budget.
Before we discuss flexible budgets, we must know the general meaning of budgets first, so that Sinaumedia friends can understand more clearly the meaning of flexible budgets.
Understanding the budget is a plan in a business or organization that is compiled in aggregate and described in monetary units for a predetermined period or period of time.
The budget is often referred to as a financial plan because the budget prepared is expressed in monetary units. Corporate budgeting is a process that is planned and controlled for the purpose of estimating company finances.
A company within a company must have a budget plan as a form of tracking the company’s internal economic growth. Budgets that have important goals and interests in a business are usually prepared at the beginning of the year for a period of one year or more.
The purpose of the budget is to clearly and formally present the goals/expectations of the organization. In this way, the organization avoids confusion and provides direction on what management wants to achieve.
The next objective of the budget is to provide detailed information about planned activities. In this way, uncertainty will be reduced and the direction of individuals and groups within the organization will become clear to achieve the goals of the organization.
Using a budget properly and precisely is one of the important points in the operation of a business. This type of budget is considered ideal and can help a business achieve various goals and get the maximum profit from its business.
Basically every company will have its own way of preparing this budget, because there are several budgets to choose from, one of which is a flexible budget.
In this article, Sinaumedia will help you understand what a flexible budget is and how it can be created for the benefit of your business. Let’s look at the following explanation.
Definition of Flexible Budget
Referring to the explanation of the Financial Services Authority (OJK), the definition of a flexible budget is a budget that can accept changes in calculations and costs. This budget can show how different types of expenses can be different for different volumes of production and sales (flexible budget) .
Definition of a flexible budget is a budget that can adapt to changes in the amount of production and activities within the company. These budgets are more modern and useful than static budgets that cannot be changed once approved.
For various expenses in company activities, this budget is flexible because it has variable rates for each unit and is not included in the number of units. This makes flexible budgets easier to use as a measurement tool to see how well managers are performing in each unit.
In addition, a flexible budget is a company system for planning and developing a budget if the results of its activities are not fixed or variable. In other words, a flexible budget is one that allows different spending levels to be calculated for different expenses.
In general, the budget itself is divided into 2 types, namely flexible budgets and fixed (static) budgets. The definition of a fixed budget is a budget that is set on the basis of fixed production or sales. Of course, these two types of budgets aim to help business leaders manage business finances properly and correctly.
There are two ways to approach a flexible budget: from a business finance perspective and from a personal finance perspective. From a business finance perspective, a flexible budget is a budget plan that adapts to changing costs, volumes, and revenues.
Simply put, the way a business calculates its budget, estimates its needs, and how many goals it wants to achieve. Meanwhile, from a personal finance perspective, flexible budgeting is a method of planning a financial budget that is prepared based on financial conditions, income and expenses.
Then, adjust it to changes in consumption habits that occurred in the previous year. Typically, personal budgets are adjusted at monthly intervals when all kinds of common billing cycles occur frequently.
Flexible Budget Goals
Flexible budgets can also be used to calculate different business financing activities, such as how much to spend on various expenses incurred during a certain period. The amount of these royalties will inevitably vary depending on the size of changes in the company’s income, including changes in the company’s operations itself.
Flexible budgets are made with the aim that the company’s financial managers can refer with a high degree of accuracy between the actual results and the budgeted budget. This is why flexible budgets can be adjusted according to activity level or production volume. This is intended to make it easier for cost owners to determine the budget when analyzing variable costs.
Although flexible, the main purpose of a flexible budget is to limit overspending. In this way, financial managers are expected to be able to identify areas that are effective and underperforming to be evaluated in future plans.
To achieve this goal, management must carefully compare budget statistics and actual performance to find areas to evaluate, in the form of budget cuts or additions.
Flexible Budget Function
Flexible budgets can even be used after the end of an accounting period as an evaluation tool, to find out the success of each area or unit in the company during this period.
Management can do this by comparing each budgeted figure to the statistics of performance achieved so that improvement can be seen and areas for improvement can also be identified.
A flexible budget can also be used to calculate the different financial activities of a business, such as how much to spend on various expenses that occurred during a certain period. The amount of these royalties will inevitably vary depending on the size of changes in the company’s income, including changes in the company’s operations itself.
Flexible Budget Types
A company can produce several variations of flexible budgets that range from basic to advanced depending on the needs of the company. The following are the three most commonly used types of flexible budgets:
1. Basic Flexible Budget
This type is flexible with a company’s expenses changing directly with respect to its income. Articles of association can be made in percentages that vary based on income. This type of budget is usually used to show unit costs or a percentage of sales.
2. Medium Flexible Budget
This type of budget takes into account expenses that exceed the company’s revenue. Usually, this budget includes expenses related to activities other than or not revenue. For example, the cost of a business insurance policy can vary based on how many employees a company has and can increase if the company hires new employees.
3. Advanced Flexible Budget
This type of budget takes into account the variation and range of costs based on each category of the company’s budget. This advanced level of budget will also change based on actual spending for each category.
Flexible Budget Forms
A flexible budget has 3 forms, namely:
1. Formula form
This form is a budget prepared in a form that clearly describes only the variable and fixed elements of each cost element.
2. Table form
This form uses tabular form budgets, one can see the cost of each item at different levels of activity or production. This budget does not feature variable and fixed elements.
3. Graphic Forms
This form is a budget that completes the two budgets above (formula and table). In addition, there is also a frequently used activity-based flexible budget. Flexible activity-based budgeting is a budgeting method based on the quantification (counting and measuring) of business activities and their associated costs.
In activity-based flexible budgeting, the process of allocating funds is carried out by the business by first identifying the main activities to achieve business goals. The company then calculates costs and creates an additional budget based on activity. This can also minimize the incurrence of debt when carrying out predetermined activities.
Advantages of Using a Flexible Budget
This type of budget can bring a company a lot of advantages. Here are some of the benefits a business can get from using a flexible budget:
Adjustments based on profit margins and costs
This type allows a company to have a more realistic budget idea based on the evolution of costs and profit margins.
While a static budget remains the same as it was created at the start of a new year, a flexible budget takes into account cost reductions or increases and helps businesses make adjustments to compensate.
Potential to maximize revenue
While static budgets don’t change to reflect increased sales, flexible budgets do. As a result, businesses can better know where they can improve their marketing or other efforts as revenue grows.
Better cost control
This budgeting process lets businesses know when to make certain cost changes. For example, if sales forecasts are lower than expected, using this budget will also show the most recent percentages from each category allowing the business to make necessary adjustments to its costs to compensate for decreased sales.
Disadvantages of Using a Flexible Budget
Like many accounting tools, flexible budgeting can also have a downside. Understanding the limitations of this type of budgeting can help you determine whether budgeting this way is right for your business. Here are some possible downsides to using this budgeting process:
Lack of income comparison
Because a flexible budget adjusts periodically to reflect current business revenue, this type of budget cannot be used to compare actual costs or revenue to planned costs or revenue. As a result, it is difficult to determine whether a company’s earnings were above or below expectations.
Flexible budgeting can be difficult. This is because all costs that a business may incur are constant and should be included in the budget as fixed costs. Calculating each type and determining the type of fee needed can be difficult and time consuming.
Not always applicable
This type of budgeting may not be beneficial for some businesses, especially those with a large proportion of fixed costs. For example, a business with low or zero COGS and a fixed total cost per month is unlikely to benefit from a flexible budget plan.
Flexible Budget Formula
If you think a flexible budget will help you manage your budget, you need to know what steps you need to take to design a flexible budget. Here’s a formula you can use to create a flexible budget for your business:
1. Distinguish between variable costs and fixed costs
A financial manager must be able to find the difference between fixed costs and variable costs. Examples of fixed costs are rent, advertising budget, and others. Whereas variable costs usually include raw material costs, labor costs per unit, etc. Once you know your fixed and variable costs, make a production plan from this data.
2. Update the company’s financial budget plan
Tailor your planned budget to monthly or quarterly sales or productivity, depending on the accounting period your business uses. This will help you find the right number for your budget allocation.
Compare the plans you make each month, so you will know which positions are in excess and which are in deficit. From this data, you can also estimate and plan a budget for the next accounting period.
Flexible Budget Deviation Analysis
In preparing a flexible budget, deviations (variances) can occur. Basically, flexible budget variances are divided into two categories, namely:
1. Deviation of Effectiveness
This deviation is also known as volume deviation or target deviation.
Examples of effectiveness deviations:
The production target set by the company was 80,000 units but only 65,000 units were achieved, so this situation was called ineffective.
2. Efficiency Deviation
Efficiency deviations occur due to changes in price per unit or due to inefficient use of inputs, namely the input budget is smaller than the actual input. The task of company management is to find obstacles related to these irregularities and find solutions.
How to Create a Flexible Budget
Here are steps you can take to create a flexible budget for your business:
1. Determine which costs are variable and which are fixed
Fixed costs usually include expenses such as rent and monthly marketing fees. Once you’ve determined which costs are fixed and which are variable, separate them out on your budget sheet.
2. Divide the budget
Divide your projected variable cost budget by your production forecast. This will provide an initial budget for unit costs.
3. Create your budget with defined fixed costs
Create your budget by setting fixed costs that will not change and variable costs expressed as a percentage that can be adjusted based on actual sales.
4. Update the budget
When the accounting period ends, update your budget with actual sales and/or activity metrics. It will adjust the variable costs according to the exact data from the accounting period.
5. Input and compare
Enter the final flexible budget for the accounting period into your accounting software to compare with your originally planned costs.
Example of Making a Flexible Budget in Business
Next, are examples of how flexible budgeting can be used by businesses:
Company B has estimated revenue of $5 million and cost of $1 million. The company has determined that $400,000 of $1 million in cost of goods is fixed, and $600,000 in cost of goods will vary with sales.
This means that variable or flexible cost of goods make up 12% of the company’s revenue. At the end of the accounting period, Company B determines that its actual sales were $6 million, $1 million higher than expected.
Using flexible budgeting, fixed costs would be fixed at $400,000, while the variable portion of cost of goods would be adjusted to $720,000 to reflect the 12% allocated to this capital cost portion. As a result, the company will be able to include an additional $120,000 in the goods variable cost budget to account for increased sales.