Do you suppose that preparing budgets is wasting your time? If yes, you may be doing it wrong. You probably dutifully make a static budget every single year and put it somewhere – and you don’t see this budget till you start preparing a new one. The good news is that I know how to create a budget in the right way and want to share this knowledge with you.
It is better to give preference not to a static budget, but to a flexible one. Flexible budgets are slightly better than the static ones. After you understand how to calculate the flexible budget, it will become one of the main management tools for you.
What is a Flexible Budget?
A flexible budget is a budget that can be adjusted depending on an assumption changes used for creating the budget during the planning process of management. A static budget exists as well. The primary difference between a static budget and a flexible budget is that a static budget does not change even if the assumptions didn’t come into reality and there are significant changes.
When comparing the static budget vs. flexible budget, the last one is supposed to be better thanks to its adaptability. In reality, change is real and constant. A flexible budget is capable of handling the reality.
The answer to the question „What is the primary difference between a static budget and a flexible budget?” is that the last one is more useful and sophisticated than a static one. No matter what the volume of activity is, it remains at one amount.
What is a Flexible Budget Variance
A flexible budget variance is a distinction between:
- the amount allowed by the flexible budget;
- the actual amount.
To help you understand what this notion means, let’s imagine that you work as a manager of a shipping department. You have prepared the annual budget of your department basing on the assumption that the company will ship 50,000 items during the budget year. In case the annual budget does not change when roughly 50,000 items are already shipped, this is called a static budget.
How Does the Flexible Budget Work?
Now I will explain to you how to find a flexible budget. First of all, you identify and budget for the expenses that are fixed. This stage is the same as creating a static budget; the task of management is to determine how big your expenses will be and implement them into your budget as fixed expenses. Don’t forget that the expenses are what they are, and they probably will not change. To get the logic, you can consider the rent expense.
After having taken care of the fixed expenses, the next step is turning to the variable expenses. These expenses should be calculated basing on other items determined over time. For instance, management can show that marketing expenses should be worth 15% of income each quarter.
In case the first quartet brings $500,000 in revenue, the marketing budget will be 15% of that, or $75,000.
In case this revenue is lower, for example, $400,000, there will be a reduction of the marketing budget. At $400,000, the marketing budget will be $60,000.
You can also look at the best financial blogs to create your own flexible budget formula.
Updated With Current Data
Expenses and revenues are adjusted inflexible budgets for operating conditions all the time. If the environmental regulations change, it may increase the production costs and the purchase of various types of machines may be necessary. For example, bad weather can increase the costs of shipment and result in delays.
When creating a flexible budget, managers are updating their projects all the time. The main perk of the flexible budget is that it can adapt to the changes that happen in the real world.
Now you caught the idea of the flexible budget. You know what the difference between static vs. flexible budget is and how to calculate a flexible budget. If you have some other ideas, you can share them in the comments below.
Also, take a look at budgeting tips for moms to learn something new!