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Characteristics Of Flexible Budget And Steps To Be Followed For Preparing A Flexible Budget

Zero based budgeting takes more time to create as all pieces of the budget need to be reviewed by management. Production budget – an estimate of the number of units that must be manufactured to meet the sales goals. The production budget also estimates the various costs involved with manufacturing those units, including labour and material.

Such budgets also rely on the assumption of continuity when costs may actually behave in a stepped or discontinues manner. Flexed budgets assume linearity of costs and, therefore, take no account of, for example discounts for bulk purchases of materials. ‘Labour’ costs are unlikely to behave in a linear fashion unless a piecework scheme is in operation. Classify all costs into fixed, variable and semi-variable categories. The factors of production are prone to certain limitations and are not in human control.

Limitations Of Flexible Budgets

A fixed budget is one that is prepared keeping in mind a single level of output. It is defined like a budget which is created to remain the same irrespective of the level of activity gained. If actual output varies from budgeted level of output, variances will come up. Fixed budget is prepared on the assumption that sales and output could be estimated with a good degree of accuracy. This implies that in those situations in which output and sales cannot be correctly estimated, fixed budget does not suit. The Flexible budgeting approach is more practical and realistic than static budgeting.

We should also acknowledge up front that there’s almost always a gap remaining between what we’re able to analyze and say for sure and what we decide to do. ACCOUNTING is primarily a system of measurement and reporting of economic events based upon the accounting equation for the purpose of decision making. Generally, when someone says “accounting” they are referring to the department, activity or individuals involved in the application of the accounting equation.

Accounting Topics

Variance Analysis provides useful information as each cost is analyzed according to its nature. Thus it becomes difficult for the experts to prepare Flexible budgets. Most families, for example, spend variable amounts of money on groceries each month. In addition, you’re likely to spend different amounts each month on putting gasoline in your car and paying for necessary car repairs and maintenance. Variable expenses represent those daily spending decisions like eating at restaurants, buying clothes, drinking Starbucks, and playing a round of golf with your buddies. There are two basic approaches or philosophies when it comes to budgeting.

It has been defined as a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained. It is rigid budget and is drawn on the assumption that there will be no change in the budgeted level of activity. It does not take into consideration any change in expenditure arising out of changes in the level of activity.

Disadvantages Of Flexible Budgeting

It makes managers cost conscious and helps them in identifying priorities in the overall interest of the organisation. Allotment of funds based on the above resulting by following pyramid ranking system to ensure optimum results. Identification of decision units in order to justify each item of expenditure in their proposed budget. In ZBB, by delinking the budget from the past, the past mistakes are not repeated. Funds required for any activity for the next budget period should be obtained by presenting a convincing case.

It can be freely adjusted or re-casted on the basis of output produced. It is logical and practical because the cost can be easily determined at various activity levels. This budget can be prepared even if the activity level is not decided since fixed costs are already known to every department and variable costs can be approved as a percentage of sales per unit. Company B has budgeted for $5 million in revenue and $1 million in cost of goods sold. The company has determined that $400,000 of the $1 million of the cost of goods sold is fixed and $600,000 of the cost of goods sold will vary based on its revenue. This means that the variable, or flexible, the amount of cost of goods sold is 12% of the company’s revenue.

Flexible Budget Definition, Fixed Budget, Flexible Budget

Hence, any error in books of accounts can mislead the budget preparation. It is because the base of the budget starts from the past performance of the company. Just make sure that you are actually using it to build good financial responsiveness, not using it to break good financial habits. This is the section that accounts for utilities, student loan payments, car payments and other fixed expenses that you can’t easily modify. Housing should occupy its own category; for renters, it will likely have little more than “Rent.” Flexible budgeting allows you to adjust your savings and spending based on how you actually live your life, not based on a hypothetical sketch of how you should live it.

Funds are used on priority basis and hence there is better allocation of resources. In order to improve the production process, an expenditure of Rs. 1,000 was incurred for research and development activities. The Administrative Reforms Commission of India recommended in 1967 the introduction of performance budgeting in major spending departments in India. Although same initial efforts were made in this direction by the centre and some of the states, but it did not get wide acceptance. Performance reporting indicating the result of analysis of the variance from the budget is done like that of variance reporting. A current budget can be defined as a budget which is related to the current conditions and is prepared for use over a short period of time. This budget is more useful than a basic budget, as a target it lays down will be corrected to current conditions.

Advantages Of Flexible Budgeting Approach

If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance. The static budget is intended to be fixed and unchanging for the duration of the period, regardless of fluctuations that may affect outcomes. When using a static budget, some managers use it as a target for expenses, costs, and revenue while others use a static budget to forecast the company’s numbers. In business, a flexible budget is one that you adjust based on changing costs and revenue. You build your budget at the beginning of the fiscal year, accounting for how much money your business has, needs and expects to make.

By flexing its budget a company can anticipate and accommodate its needs. For example, a seasonal business might create a flexible budget that anticipates changing staff levels as customers come and go over the course of the year.

What Are Flexible Budgets?

This flexible budget is unchanged from the original because it consists only of fixed costs which, by definition, do not change if the activity level changes. Unlike a static budget, a flexible budget changes or fluctuates with changes in sales, production volumes, or business activity. A flexible budget might be used, for example, if additional raw materials are needed as production volumes increase due to seasonality in sales. Also, temporary staff or additional employees needed for overtime during busy times are best budgeted using a flexible budget versus a static one. Initially, a new venture can’t predict demand for its product accurately; hence, a flexible budget can be of great help. So, it can prepare flexible budgets with different levels of output based on the analysis of the demand for a similar product. Therefore, we can conclude that with the change in the machine hours of the factory, the flexible budgets also change.

Thus, a budget is developed on the basis of incremental changes from the previous year’s figures taken as base. Zero-base budgeting is most appropriate in controlling these staff and support areas, (i.e. non-manufacturing overhead). Thus in performance budgeting classification of expenditure follows a three tier pattern viz. Programme or production goals in physical and financial terms are established in accordance with this new classification and after the period, the actual performance is compared. Income taxes are budgeted as 40% of income before income taxes. The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250. Actual expenses are lower because the income before income taxes was lower.

Operating CostsOperating expense is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit. Input the final flexible budget from an accounting period into your accounting software to compare it definition of flexible budget to the expenses you initially anticipated. Fixed costs typically include expenses such as rent and monthly marketing costs. Once you have determined which costs are fixed and which are variable, separate them on your budget sheet. Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance.

A big organization should hire experts to prepare a flexible budget and to help their organization make a clear vision about what output should be produced to achieve the targeted profit. The result cannot come out to be correct if there are any mistakes in the Books of Accounts provided. A flexible budget depends very much upon a forecast of the past business performance.

• Where the undertaking is suffering from shortage of a factor of production such as materials, labour, plant capacity etc.
• It doesn’t tell you what should be important to you; it tells you what is actually important to you, at least in terms of your spending, so you can decide whether or not you’re OK with that.
• At the end of the accounting period, Company B determines that it actually had sales that equaled $6 million, which is $1 million more anticipated.
• This type of budgeting changes with a company’s level of activity or volume and is especially useful for businesses that see a lot of variations in cost-related activities throughout the year.
• In our example, the company might have set a target of 90% production, revised it to 85% and still would have achieved a 75% production level.
• Unlike a static budget, which does not change from the amounts established when the budget was created, a flexible budget continuously “flexes” with a business’s variations in costs.

Your health insurance, car insurance, life insurance, and homeowners or renters insurance are also examples of fixed costs. You would have to spend several hours researching alternate plans to change these monthly payment amounts. Conditional budgeting is a budgeting approach designed for companies with fluctuating income, high fixed costs, or income depending on sunk costs, as well as NPOs and NGOs. The other school of thought holds that it’s not about models, it’s about people. No matter how sophisticated models can get, the best information comes from the people in the business. The focus is therefore on engaging the managers in the business more fully in the budget process, and building accountability for the results.

A flexible budget will help you track where you can adjust spending each month. This is particularly important when you’re hoping to build savings or work towards a larger financial goal. When you must adjust your spending on an ad hoc basis, most often you end up short-changing your savings.

• It is logical and practical because the cost can be easily determined at various activity levels.
• Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information.
• Therefore, many Industries and companies can’t use this budget despite its enormous advantages.
• This does not mean management ignores differences in sales level, or customers eating in a restaurant, because those differences and the management actions that caused them need to be evaluated, too.
• But is such system of budgeting control of performance in terms of physical units or the related costs cannot be achieved.
• They made it flexible because the specific company’s or department’s needs do not remain static.

Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. Paula Pant is an expert on retirement planning, financial planning, debt management, and budgeting who speaks and writes regularly on personal finance subjects. She graduated magna cum laude from the University of Colorado at Boulder and is a real estate investor with multiple rental properties. Zero based budget – A budget type where every item added to the budget needs approval and no items are carried forward from the prior years budget. This type of budget has a clear advantage when the limited resources are to be allocated carefully and objectively.