Understanding Flexible Budgeting in FP&A

He is the sole author of all the materials on AccountingCoach.com. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. As companies get larger, with more sophisticated finance operations, more data and more people involved, expectations should be higher. Creating a budget, even one that’s not constantly evolving, can be an overwhelming to-do on the never-ending checklist facing leaders of emerging businesses. Cash is the lifeblood of any business — and allocating it effectively is integral to success. But, in a happier scenario, what if the coffee shop exceeds expectations and operates at 120% of original expected activity?

If the machine hours in February are 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March has 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). Determine the extent to which all variable costs change as activity measures change. Note that fixed expenses and variable cost ratios didn’t change, because they don’t vary based on activity. However, variable expenses shifted considerably based on the number of customers, warranting the extra monitoring and maintenance. Once you identify fixed and variable costs, separate them on your budget sheet.

Pros of a Static Budget

It is essentially a way to comprehensively account for the static budget’s cost variance. You can keep your flexible budget expenses to a minimum by offering performance incentives to your employees, as long as they are directly related to sticking to the static budget. For example, let’s say a company’s original budget was based on producing 10,000 units of a product.

They can use their various expected levels of production to create a flexible budget that includes these different levels of production. Then, they can modify the flexible budget when they have their actual production volume and compare it to the flexible budget for the same production volume. A flexible budget is more complicated, requires a solid understanding of a company’s fixed and variable expenses, and allows for greater control over changes that occur throughout the year. For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier. In a static budget situation, this would result in large variances in many accounts due to the static budget being set based on sales that included the potential large client.

Difficulty in Estimating Variable Costs

The result is a budget that is fairly closely aligned with actual results. This approach varies from the more common static budget, which contains nothing but fixed expense amounts that do not vary with actual revenue levels. In a flexible budget, there is no comparison of budgeted to actual revenues, since the two numbers are the same. The model is designed to match actual expenses to expected expenses, not to compare revenue levels. There is no way to highlight whether actual revenues are above or below expectations.

Flexible budgets are usually produced monthly or quarterly, rather than in advance like static budgets. For example, let’s say that you have been asked to create an operating plan for your business over the next five years. Similarly, while a static budget would limit hiring more employees, a flexible budget would adapt to the need for more staff to meet increased demand by increasing the budget for payroll expenses. It’s a budget that is prepared at the beginning of the year and not changed until it’s time to make a new one at the start of the next year. The numbers do not change for the entire year, regardless of anything that happens in the business environment.

AccountingTools

FP&A teams should analyze historical data and conduct sensitivity analyses to identify the key drivers of financial performance. While flexible budgeting has many advantages for financial planning and analysis (FP&A) teams, there are some challenges to consider. Thereafter, prepare a flexible budget for single or multiple what is flexible budget activity levels. The columns would continue below with fixed and variable expenses, allowing you to see how your net profit changes based on changes in actual production and revenue. Flexible budgets usually try to maintain the same percentages allotted for each aspect of a business, no matter how much the budget changes.