Flexible Budget Definition
A flexible budget is a type of variable budget that predicts the production or output based on a changing level of business activities. It is useful for both planning purposes and control purposes and is generally used to estimate factory costs and operating costs. A flexible budget is much more realistic than fixed budgets since it gives emphasis on cost behavior at different levels of activity.
Important Aspects
- When preparing a Flexible budget, managers are forced to consider the different scenarios and their responses to them. Thus, for a number of different situations, managers will have calculated their costs and revenues. If an unexpected event does occur, changing the level of activity, the management will be better prepared.
- Budgetary control is the comparison of the actual results against the budget. Where the actual level of activity is different from that expected, comparisons of actual results against a fixed budget can give misleading results.
- These budgets are different in different levels of activities, which facilitate the ascertainments of fixation of cost, selling prices and tendering of Quotations.
Example of Flexible Budgets
This example of a flexible budget has following details provided by a factory expected to operate at 70% level of activity (i.e. 14000 hrs)-
Now, between 85% and 95% of activity level, its semi-variable expenses increase by 10% and above 95% of activity level they increase by 20%. Prepare a flexible budget for the three scenarios wherein the activity levels are 80%, 90%, and 100%.
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Solution:
We have noticed that the recovery rate (Budgeted hrs/Total expenses) at the activity level of 70 % is $0.61 per hr. If the factory works 16000 hrs in a particular month, the allowances @ $0.61 will come put to be $9,760, which is not correct. As shown in the above table the correct allowance is computed to be $8,880.
This is because the fixed expenses don’t change irrespective of the activity level and the semi-variable expenses do change but not in proportion to the activity level. Only the purely variable expenses vary proportionately with the activity level.
Thus, if the actual expenses exceed $8,880 by $X in the month with 80% activity level, it would mean that the company has not saved any money but has overspent $X more than the budgeted amount.
Situations to use Flexible Budgeting
- In the case of a typical business, if it is newly started, it becomes very difficult to predict the demand for the products/services accurately. But this can be dealt with by putting a Flexible budget in place.
- In the case where the business totally depends upon the Mother Nature i.e. rain, dry and cold the flexible budget helps the business to estimate there output considering the good or bad weather conditions. For example agricultural activities, wool-based industries, etc.
- In case of a business which carries their entire work with the help of laborers. The laborers’ availability is a key factor for these types of companies. Therefore it helps the management to accurately know about their productivity and output. For example jute factories, handloom industries, etc.
Advantages of Flexible Budget
- It can help in sales, costs and profit calculation at different levels of operating capacity.
- It helps to determine the quantity/amount of output to be produced to help the company achieve the desired profit level.
- The biggest advantage of this budget is that it helps the management of the company to determine the production level in different market and business conditions.
- It also helps in the reclassification of various levels of budgeted costs along with sales so that managers can easily identify the profit areas and thus may act accordingly.
- This budget can be re-casted on the basis of the activity levels. It is not rigid.
Disadvantages of Flexible Budget
- This budget requires skilled workers to work on it. The availability of skilled workers becomes a challenge for the industry. Therefore, many Industries and companies can’t use Flexible budgets despite its enormous advantages.
- It depends upon the proper accounting disclosures. The result of any Flexible budget cannot come out to be correct if there are any mistakes in the Books of Accounts provided. Flexible budget depends very much upon a forecast of the past business performance. So the historical information used needs to be accurate.
- It is an expensive affair. Skilled workers are to be appointed and they should be paid for their services. It’s quite a laborious task too. Thus many companies and industries can’t afford to have a Flexible budget.
- It also depends upon the factors of the production, which are not in the hands of the management. Therefore the predictions can be inaccurate due to these conditions.
- Analysis of variance provides useful information as each cost is analyzed according to its nature. Thus it becomes difficult for the experts to prepare Flexible budgets.
Conclusion
Flexible Budget can be found suitable when the business conditions are changing constantly. Accurate estimates are expected from flexible budgets if the resources are available with the experts. A big organization should hire experts to prepare a flexible budget and to help their organization make a clear vision about what output should be produced to achieve the targeted profit.
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