Preparing a good budget plan will help the management team easily achieve organizational and business plans and goals. Armed with a good budget, management can also make estimates of costs and productivity levels, to forecast future sales fluctuations. One budget plan that can adapt to future fluctuations is a flexible budget.
A flexible budget is a budget design method that can adjust or adapt to changes in the level or volume of activities. Flexible budgets are better suited to types of activity with variable volumes than static budgets.
Flexible budgets are more effective because they measure costs up to variable costs per unit. Flexible budgets can also measure how effective a manager is. This is because flexible budgets can adjust spending based on activity levels or volume, unlike static budgets.
Before we discuss flexible budgets, we must understand the general meaning of budget first, so that Gramedia friends understand the meaning of flexible budget more clearly.
Understanding a budget is a plan in a business or organization that is prepared in aggregate and described in monetary units for a predetermined period or time period.
A budget is often referred to as a financial plan because the budget prepared is expressed in monetary units. Corporate budgeting is a planned and controlled process for the purpose of estimating a company’s finances.
A company within a company must have a budget plan as a form of tracking the company’s internal economic growth. Budgets that have important goals and interests in a business are usually prepared at the beginning of the year for a period of one year or more.
The purpose of a budget is to clearly and formally present the organization’s goals/expectations. In this way, the organization avoids confusion and provides direction on what management wants to achieve.
The next purpose of the budget is to provide detailed information about planned activities. In this way, uncertainty will be reduced and the direction of individuals and groups in the organization will become clearer to achieve organizational goals.
Using a budget properly and appropriately is one of the important points in the operations of a business. This type of budget is considered ideal and can help a business achieve various goals and get maximum profits from its business.
Basically, each company will have its own way of preparing this budget, because there are several budgets to choose from, one of which is a flexible budget.
In this article, Gramedia will help you understand what a flexible budget is and how it can be created for the benefit of your business. Let’s look at the following explanation.
Understanding Flexible Budget
If you refer to the explanation from the Financial Services Authority (OJK), the definition of a flexible budget is a budget that can accept changes in calculations and costs. This budget can show how various types of expenses can differ for different production and sales volumes (flexible budget) .
The definition of a flexible budget is a budget that can adapt to changes in production numbers and activities within the company. These budgets are more modern and useful than static budgets that cannot be changed once approved.
For various expenses in company activities, this budget is flexible because it has a variable rate for each unit and is not included in the number of units. This makes flexible budgets easier to use as a measurement tool to see how well managers in each unit are performing.
In addition, a flexible budget is a company system for planning and developing a budget if the results of activities are not fixed or variable. In other words, a flexible budget is a budget that allows different spending levels to be calculated for different expenses.
In general, budgets are divided into 2 types, namely flexible budgets and fixed (static) budgets. The definition of a fixed budget is a budget that is set on the basis of fixed production or sales. Of course, these two types of budgets aim to help business leaders manage business finances properly and correctly.
There are two ways to approach a flexible budget: from a business finance perspective and from a personal finance perspective. From a business finance perspective, a flexible budget is a budget plan that adapts to changes in costs, volumes and revenues.
Simply put, it is how a business calculates its budget, estimates its needs, and how many goals the business wants to achieve. Meanwhile, from a personal finance perspective, flexible budgeting is a method of planning a financial budget that is prepared based on financial conditions, income and expenses.
Then, adjust to changes in consumption habits that occurred in the previous year. Typically, personal budgets are adjusted at monthly intervals when all kinds of common billing cycles occur frequently.
Flexible Budget Goals
Flexible budgets can also be used to calculate different business financing activities, such as how much to spend on various expenses incurred during a certain period. The amount of these royalties will inevitably vary depending on the magnitude of changes in the company’s income, including changes in the company’s own operations.
Flexible budgets are created with the aim that company financial managers can refer with a high degree of accuracy between actual results and the budgeted budget. This is why flexible budgets can be adjusted to the level of activity or production volume. This is intended to make it easier for cost owners to determine the budget when analyzing variable costs.
Although flexible, the main purpose of a flexible budget is to limit overspending. In this way, financial managers are expected to identify effective and underperforming areas to evaluate in subsequent plans.
To achieve this goal, management must carefully compare budget statistics and actual performance to find areas to evaluate, in the form of budget cuts or additions.
Read Also : What is a Cash Account? This is the meaning, examples and benefits for business
Flexible Budget Function
Flexible budgets can even be used after the end of an accounting period as an evaluation tool, to determine the success of each area or unit in the company during this period.
Management can do this by comparing each budgeted figure with the performance statistics achieved so that improvements can be seen and areas for improvement can also be identified.
Flexible budgets can also be used to calculate different financial activities of a business, such as how much to spend on various expenses incurred during a certain period. The amount of these royalties will inevitably vary depending on the magnitude of changes in the company’s income, including changes in the company’s own operations.
Flexible Budget Type
A company can produce several variations of flexible budgets that range from basic to advanced depending on the company’s needs. The following are the three most commonly used types of flexible budgets:
1. Basic Flexible Budget
This type is flexible with a company’s expenses changing directly in relation to its revenues. Basic budgets can be created in varying percentages based on income. This type of budget is usually used to show costs per unit or percentage of sales.
2. Medium Flexible Budget
This type of budget takes into account expenses that exceed the company’s income. Typically, this budget includes costs related to activities other than or not income. For example, the cost of a business insurance policy can vary based on how many employees a company has and may increase if the company hires new employees.
3. Advanced Flexible Budget
This type of budget takes into account variations and ranges of costs based on each company budget category. This advanced budget will also change based on actual spending for each category.
Flexible Budget Forms
Flexible budgets have 3 forms, namely:
1. Form a Formula
This form is a budget prepared in a form that clearly describes only the variable and fixed elements of each cost element.
2. Table form
This form uses a tabular form of budget, one can see the costs of each item at different levels of activity or production. This budget does not highlight variable elements and fixed elements.
3. Graphic form
This form is a budget that complements the two budgets above (formula and table). Additionally, there are also frequently used activity-based flexible budgets. Flexible activity-based budgeting is a budgeting method that is based on quantifying (counting and measuring) business activities and their associated costs.
In activity-based flexible budgeting, the process of allocating funds is carried out by the business by first identifying the main activities to achieve business goals. The company then calculates costs and creates additional budgets based on activity. This can also minimize the incurrence of debt when carrying out specified activities.
Benefits of Using a Flexible Budget
This type of budget can bring many benefits to the company. Here are some of the benefits businesses can gain from using a flexible budget:
Adjustments based on profit margins and costs
This type allows companies to have a more realistic idea of the budget based on the evolution of costs and profit margins.
While a static budget remains the same when created at the start of a new year, a flexible budget takes into account reduced or increased costs and helps businesses make adjustments to compensate.
Potential to maximize revenue
While a static budget does not change to reflect increased sales, a flexible budget does. As a result, businesses can better know where they can improve their marketing or other efforts as revenue grows.
Better cost control
This budgeting process allows businesses to know when to make certain cost changes. For example, if sales forecasts are lower than expected, using this budget will also show updated percentages for each category allowing the business to make the necessary adjustments to its costs to compensate for the drop in sales.
Read Also : What are the Basic Principles of Assessment? Definition, Function and Things That Influence It
Disadvantages of Using a Flexible Budget
Like many accounting tools, flexible budgeting can also have its downside. Understanding the limitations of this type of budgeting can help you determine whether budgeting this way is right for your business. Here are some possible disadvantages of using this budgeting process:
Lack of income comparison
Because flexible budgets adjust periodically to reflect current business revenues, this type of budget cannot be used to compare actual costs or revenues with planned costs or revenues. As a result, it is difficult to determine whether a company’s earnings are above or below expectations.
Complicated formula
Flexible budgeting can be difficult. This is because all costs that a business may incur are constant and must be included in the budget as fixed costs. Calculating each type and determining the type of costs required can be difficult and time consuming.
Doesn’t always apply
This type of budgeting may not be beneficial for some businesses, especially those with a large proportion of fixed costs. For example, businesses with low or zero COGS and total fixed costs per month are unlikely to benefit from a flexible budget plan.
Flexible Budget Formula
If you think a flexible budget will help you manage your budget, you need to know what steps you need to take to design a flexible budget. Here’s a formula you can use to create a flexible budget for your business:
1. Distinguish between variable costs and fixed costs
A financial manager must be able to find the difference between fixed costs and variable costs. Examples of fixed costs are rental costs, advertising budget, and others. Meanwhile, variable costs usually include raw material costs, labor costs per unit, etc. Once you know your fixed and variable costs, create a production plan from this data.
2. Update the company’s financial budget plan
Tailor the budget plan you set to monthly or quarterly sales or productivity, depending on the accounting period your business uses. This will help you find the right number for your budget allocation.
3. Compare
Compare the plans you make every month, so you will know which positions are in excess and which are in deficit. From this data, you can also estimate and plan the budget for the next accounting period.
Flexible Budget Deviation Analysis
In preparing a flexible budget, deviations (variance) can occur. Basically, flexible budget deviations are divided into two categories, namely:
1. Effectiveness Deviations
This deviation is also called volume deviation or specified target deviation.
Examples of effectiveness deviations:
The production target set by the company was 80,000 units but only 65,000 units were achieved, so this situation is said to be ineffective.
2. Efficiency Deviations
Deviations in efficiency occur due to changes in price per unit or due to inefficient use of input, namely the input budget is smaller than the actual input. The task of company management is to find obstacles related to these deviations and find solutions.
How to Create a Flexible Budget
Here are steps you can take to create a flexible budget for your business:
1. Determine which costs are variable and which are fixed
Fixed costs usually include costs such as rent and monthly marketing costs. Once you determine which costs are fixed and which are variable, separate them on your budget sheet.
2. Divide the budget
Divide your projected variable cost budget by your production estimates. This will provide an initial budget for unit costs.
3. Create your budget with defined fixed costs
Create your budget by establishing fixed costs that will not change and variable costs expressed as a percentage that can be adjusted based on actual sales.
4. Update the budget
When the accounting period ends, update your budget with actual sales and/or activity metrics. This will adjust the variable costs according to the exact data of the accounting period.
5. Input and compare
Enter the final flexible budget for the accounting period into your accounting software to compare with your originally planned costs.
Read Also : What is Liquidity? Definition, Function, and Example Questions
Example of Creating a Flexible Budget for Business
Next, is an example of how flexible budgeting can be used by businesses:
Company B has estimated revenues of $5 million and cost of goods of $1 million. The company has determined that $400,000 of the $1 million cost of goods is fixed, and $600,000 in cost of goods will vary with sales.
This means that variable or flexible cost of goods makes up 12% of a company’s revenue. At the end of the accounting period, Company B determines that its sales were actually $6 million, $1 million higher than expected.
Using flexible budgeting, the fixed cost of goods would be set at $400,000, while the variable portion of the cost of goods would be adjusted to $720,000 to reflect the 12% allocated to this portion of the capital cost. As a result, the company will be able to include an additional $120,000 in the variable cost of goods budget to account for the increase in sales.