A fixed budget is determined at the beginning of the year based on what a business anticipates to happen, how many units they'll sell, and regular expenses. They estimate how many units of each item they will sell, among other variables. After the year is completed, they'll have the outcome of their budget. When you sell more, certain products become expensive. Businesses need a flexible budget to solve this challenge.
Budgets help plan and control. What if the budgeted activity level is off? For example, you overestimate how many units you'll sell and then utilise that money for control. A flexible budget allows you to make modifications. The budget or financial plan for costs estimated with varying production levels and revenues is flexible. Another name for this kind of budget is a variable budget. The alteration in either the activity or the volume level will cause fluctuation.
Did you know? Cost control leads to improved profit planning, which will, in turn, lead to increased profits in a flexible budget.
What is a Flexible Budget?
What is a flexible budget? When comparing the static budget with the flexible budget, several benefits and advantages are associated with using the flexible budget. The variable spending plan is one of the most effective management strategies. In general, the static budget is different from the flexible budget. In a static budget the figures will not change for the entire year regardless of what occurs in the firm's organisational structure.
But in contrast to the static budget, the flexible budget means the budget can be altered with the planning of activities at many levels and with costs and income. In the case of a flexible budget, any necessary adjustments are made throughout the year to account for actual sales levels. When there is a shift in the circumstances, there is also a corresponding shift in the production costs that are included in flexible budgets.
Flexible Budget Format
A flexible budget format involves the steps needed to implement the plan and develop a flexible budgeting plan for an organisation. It is necessary to develop a preliminary budget before one can go on to developing a flexible budget. You can consider the original figures to make a flexible budget capable of accounting for both a rise and a reduction in the amount of income.
When creating a flexible budget format using the table technique, each level is represented by a horizontal column. The vertical rows demonstrate the expected budget in comparison to the various levels of production. The expenditures may be divided into a variable, fixed, and semi-variable.
The graphical representation of a flexible budget will include the x-axis indicating the activity level and the y-axis reflecting the cost estimate. The chart illustrates the costs that have been planned according to the activity levels. After that, it contributes to performance management.
Steps to Create a Flexible Budget
Let's understand the concept using the flexible budget example:
- In the first phase, a business will need to generate a fixed budget for their overhead expenses.This is good for exempting the normal production levels and the related charges. The fixed budget will also be used as the foundation for the variable budget deviations included in the flexible budget.
- The next step is determining the fixed and variable costs pertaining to the period. When it comes to creating an accurate business objective, the first thing you need to do is separate the fixed costs from the variable costs. This will allow you to establish an accurate business objective. For this reason, the flexible budget will only be concerned with variable expenditures, such as the levels of labour output and the materials.
- The production level entry, determined by the actual production cost, is the third phase. To create a flexible budget, you must use the actual production from the month before.
Consider the following example to understand better the concept of a flexible budget.
If a company is producing 50,000 units during January, and wants the budget for February to be 75,000 units, then they need to look at the variable expenses.
We will suppose that the cost of indirect materials for manufacturing 50,000 units was ₹22,000 and the cost of indirect labour was ₹19,000.
Therefore, at this point, they are required to generate a flexible budget. To do so, divide the entire cost of each category by the total number of units.
22,000 / 50000 = 0.4
This reveals that the proportion of indirect material costs to total material costs per unit is 0.4.
Now that we have the direct labour cost, we can calculate the indirect labour cost, equal to 19000 divided by 50000, which is 0.38.
The flexible budget will include these sums, and the production base will reflect their presence. Suppose you plan to produce 75,000 units during February and create a budget for that production. In that case, the total of the budget will be shown in the budget where it is calculated, and the flexible budget indirect material cost will be as follows:
0.4 x 75000 Equals ₹33000.
Similarly, the computation of the expenses associated with indirect labour is ₹0.38 multiplied by 75,000, which will be ₹28,500.
Advantages of Flexible Budgeting
Here are some of the advantages of flexible budgeting:
- When there are varying degrees of activity, the flexible budget decides how much money should be spent.
- The cost estimates created via flexible budgeting assist in comparing the real cost that takes place at the activity level.
- Using a flexible budgeting system assists with regulating and planning expenses.
- The development of cost factor differences at activity levels may also be provided with flexible budgeting and cost variance analysis.
- The discovery of operational inefficiencies is possible by using flexible budgeting, which is also how the control function can be used to make corrections.
- Establishing a business's pricing and quotations for contracts can be done by using flexible budgeting, which allows for the procurement of projects.
- The productivity of workers can be evaluated using flexible budgeting, which also plays a role in creating key personnel.
Disadvantages of Flexible Budgeting
Here are some of the disadvantages of flexible budgeting:
- Disclosure of financial information in an accurate manner is necessary for the implementation of a flexible budget. Any inaccuracy in the books of accounts can potentially throw off the budget's creation. There is also a possibility that the variable costs of the flexible budget will increase.
- The production will have many ups and downs since it will depend on the production variables, and the management will not have any control over these aspects.
- It won't be easy to analyse cost variations since the components of different costs are not the same.
- The variable cost will be a smaller fixed cost on an ordinary basis. As a result, the cost of the flexible budget will be less related to the cost of the budget of the activity level.
Also Read: Know All About Cost Accounting
A budget for an organisation is referred to as being "flexible" if it is created to adapt to various activity and volume levels. The flexible budget is not the same as the initial budget. The amount that was established when the budget was created will be subject to change in the flexible budget. This type of budgeting will include the variable rate per unit rather than the fixed amount. This will allow the firm or organisation to plan for the anticipation of decreases and potential increases in the need for a financial basis. There will be continuous flex in the cost variations of the business in the flexible budget, and this type of budgeting will include the variable rate per unit rather than the fixed amount.
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