Flex budgeting definition
/What is Flex Budgeting?
A flexible budget, or “flex” budget varies with changes in the amount of actual revenue earned. In its simplest form, the flex budget will use percentages of revenue for certain expenses, rather than the usual fixed numbers. This approach results in better comparability of budgeted and actual results.
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.
Steps Required to Create a Flexible Budget
A flexible budget is relatively complicated to produce, requiring more steps than are needed for a statis budget. Here are the key steps involved in the creation of a flexible budget:
Identify relevant costs and revenues. Begin by distinguishing between fixed and variable costs within the organization’s operations. Fixed costs remain constant regardless of activity level, while variable costs change proportionally with production or sales volume. Accurate classification is essential, as flexible budgets adjust variable costs according to actual activity levels.
Determine the activity measure. Select an appropriate activity base, such as machine hours, labor hours, or units produced, which drives the business’s revenue and expenses. This measure should align closely with cost behavior patterns and operational scale. The chosen driver becomes the foundation for adjusting budget amounts in response to actual performance.
Develop cost formulas. Create formulas that express variable costs as a function of the chosen activity level, typically in the form of “cost per unit of activity.” These formulas allow the budget to flex up or down based on actual performance. Including mixed costs, which have both fixed and variable components, may require a segmented approach for accuracy.
Prepare the flexible budget for a range of activity levels. Using the cost formulas, prepare budget scenarios for various levels of output or activity, such as 80%, 100%, and 120% of expected volume. This helps management anticipate changes in costs and revenues under different conditions. The flexibility aids in better decision-making and variance analysis during performance reviews.
Compare actual results to the flexible budget. After the period ends, adjust the budget to match the actual level of activity, then compare it to the actual financial results. This comparison highlights variances due to efficiency, pricing, or spending, rather than volume changes. It provides a clearer picture of operational performance and supports corrective actions.
Advantages of Flex Budgeting
This allows for an infinite series of changes in budgeted expenses that are directly tied to revenue volume. This approach is more useful than a static budget, since a flexible budget responds to changes in actual revenue levels.
However, this approach ignores changes to other costs that do not change in accordance with small revenue variations. Consequently, a more sophisticated format will also incorporate changes to many additional expenses when certain larger revenue changes occur, thereby accounting for step costs. By making these changes to the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity.
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Problems with Flex Budgeting
Though the flex budget is a good tool, it can be difficult to formulate and administer. One problem with its formulation is that many costs are not fully variable, instead having a fixed cost component that must be included in the flex budget formula. Another issue is that a great deal of time can be spent developing step costs, which is more time than the typical accounting staff has available, especially when in the midst of creating the standard budget. Consequently, the flex budget tends to include only a small number of step costs, as well as variable costs whose fixed cost components are not fully recognized.