A budget is a future-oriented strategy. Therefore, budgets are planning tools, and they are often produced prior to the beginning of the budgeted period.
However, comparing the budget to the actual results offers useful performance information. Budgets are, therefore, both planning and performance evaluation instruments.
Typically, the single most significant budget input is a measure of expected output. This output metric for a factory is the quantity of each product produced. For a retailer, it may be the quantity of each item sold. It refers to the number of patient days for a hospital (the number of patient admissions multiplied by the average length of stay).
What is a Flexible Budget?
A flexible budget is a method for evaluating performance. It cannot be prepared before the period’s end. A flexible budget adapts the static budget to the actual production level. The flexible budget asks, “What would my budget have looked like if I had known my output volume (units produced or units sold) at the beginning of the period?”
The purpose of the flexible budget is to make apples-to-apples comparisons. If the factory really produced 10,000 units, management should compare actual manufacturing expenditures for 10,000 units to what the factory should have spent to create 10,000 units, not 9,000 units, 11,000 units, or any other level of output.
A flexible budget can be created for any organization, but it is most commonly used in manufacturing. This is because manufacturing generally has more variable costs than other businesses. A flexible budget can be created for a single product or a group of products.
The flexible budget is created by estimating each activity’s cost at different output levels. The company then creates a table or graph showing the total production cost at each activity level. This budget can be used to predict future costs or compare actual costs to budgeted costs.
A flexible budget is a valuable tool for cost management because it allows the company to see how costs change as output changes. This information can decide pricing, production levels, and other factors. The flexible budget can also be used to compare actual costs to budgeted costs. This comparison can help the company identify areas where costs are higher than expected and make changes to improve efficiency.
What is Flexible Budget Variance?
The flexible budget variance is the difference between any line item in the flexible budget and the corresponding line-item from the statement of actual results. This difference might be positive or negative.
Steps to Prepare a Flexible Budget
- Determine the variable cost per unit of production that has been budgeted. Determine the budgeted price per unit of production if the budgeted entity earns income (e.g., the retailer or the hospital).
- Determine the budgeted level of fixed costs.
- Determine the volume of production accomplished (e.g., units produced for a factory, units sold for a retailer, patient days for a hospital).
- Construct the flexible budget using the budgeted cost information from stages 1 and 2 and the actual production volume from step 3.