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Flexible Budget

Flexible Budget Overview

A flexible budget shows the expected revenues and expenses for various levels of production or sales activity. This is much more useful than a static budget, which is fixed at a single amount of assumed corporate activity, which is likely to diverge greatly from actual activity over the budget period. Conversely, a company using a flexible budget can compare its results to a relevant model throughout its budget period. A flexible budget is also useful for planning over longer periods than the budget cycle, since it is easy to model different scenarios and see how they impact revenue and profit levels.

The Flexible Budget Model

In a flexible budget model, you can set up each expense line item as either a flexible expense account or one that is fixed within a broad range of revenue levels.  If it is fixed, there is no need for change, unless there is an enormous alteration in budgeted revenue levels.  However, many other expenses will vary directly with revenue; in these cases, it is possible to revise the budget formulas so that they are listed as percentages of the monthly revenue level.  By making these formula alterations, it becomes an easy matter to adjust revenue and see a swath of expense changes ripple through the budget model - with no manual intervention whatsoever.

Though the flex budget discussion has centered on tying expenses to specific revenue levels, it is also possible, and probably more accurate, to tie some expenses to other levels of activity.  For example, telephone usage or office expenses should be linked more properly to the number of budgeted employees, while utility costs can be tied either to square footage used or the number of machines in operation.  Thus, it is possible to link expenses to a number of activity measurements in a flexible budget.

Flexible Budget Example

Harrison Company does telemarketing, so nearly all of its expenses are tied to telephone usage and employee payroll. This is a difficult work environment, so employee turnover is high, resulting in significant staffing fluctuations. Harrison's controller finds that the company uses the same amount of square footage, no matter how many employees it has, and so fixes the building rent at $100,000/month through the entire budget period. However, the company connects and disconnects phone lines depending on the number of employees, so telephone usage varies directly with the number of staff. Thus, the controller builds into the model a monthly charge of $500 per employee for telephone usage.

In May, Harrison employs 219 people, so the flexible budget for telephone expense is $109,500. The rent budget for the month is $100,000.

However, is a purely variable cost structure valid? In most cases, there will be a baseline amount of cost, above which there is some variability in cost structure. For example, Harrison Company probably incurs a monthly line charge for its telephone service, irrespective of whether anyone is using the line. Thus, the actual phone cost for Harrison may be a $100/month fixed cost for every phone line, plus a variable monthly charge of $400 per employee for telephone usage. Given this more likely scenario, the flexible budget calculation for many budget line items will be:

Fixed cost + (variable cost per unit x number of applicable units)

The Flexible Budget Template

A flexible budget is extremely company-specific, because costs may vary with a wide variety of factors that cannot be addressed in a standard "boilerplate" model. Nonetheless, and assuming that all expense vary with revenue volume, here is a very general template to use for constructing a flexible budget:

* Percent of revenue

Flexible Budget Variances

The primary variance used in conjunction with a flexible budget is the flexible budget variance, which is simply the difference between a revenue or expense line item in the flexible budget model and actual results.

To prepare this variance, you wait until the end of the reporting period to see what the actual results are, and then load the relevant activity into the model to determine the results of the flexible budget, and then compare the resulting flexible budget to your actual results.