Flexible Budget:
A flexible budget is a
budget that adjusts or flexes for changes in the volume of activity.
The flexible budget is more sophisticated and useful than astatic
budget, which remains at one amount regardless of the volume of
activity.
Assume that a manufacturer determines that its cost of electricity and supplies for the factory are approximately $10 per machine hour (MH). It also knows that the factory supervision,depreciation, and other fixed costs are approximately $40,000 per month. Typically, the production equipment operates between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH.
Now let's illustrate the flexible budget by using some data. If the production equipment is required to operate for 5,000 hours during January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the equipment is required to operate in February for 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March requires only 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH).
If the plant manager is required to use more machine hours, it is logical to increase the plant manager's budget for the additional cost of electricity and supplies. The manager's budget should also decrease when the need to operate the equipment is reduced. In short, the flexible budget provides a better opportunity for planning and controlling than does a static budget.
Assume that a manufacturer determines that its cost of electricity and supplies for the factory are approximately $10 per machine hour (MH). It also knows that the factory supervision,depreciation, and other fixed costs are approximately $40,000 per month. Typically, the production equipment operates between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH.
Now let's illustrate the flexible budget by using some data. If the production equipment is required to operate for 5,000 hours during January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the equipment is required to operate in February for 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March requires only 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH).
If the plant manager is required to use more machine hours, it is logical to increase the plant manager's budget for the additional cost of electricity and supplies. The manager's budget should also decrease when the need to operate the equipment is reduced. In short, the flexible budget provides a better opportunity for planning and controlling than does a static budget.
Fixed budgets and flexible
budgets both are forms of budgeting that are essential for any
business that wishes to exercise control, induce proper decision
making and coordinate business activities. Fixed budgets are more
suitable for businesses that operate in a less dynamic business
environment, whereas flexible budget are best for firms that operate
in a turbulent market. A fixed budget is much easier to prepare than
a flexible budget since it does not require constant revision,
whereas flexible budgets are much more complex since the scenarios
considered are greater in number. The accuracy of a flexible budget
can be easily affected owing to the variability of the business
environment the firm is in. Flexible budgets are mostly preferred by
firms because they allow the firm to conduct scenario planning and
better adjust for unexpected situations.
• Flexible budgets reflect the levels of business activity and output to be produced in line with the changes in the business environment, whereas flexible budgets are prepared on the assumption that the future of the business will not be much different from its past.
• Flexible budgets allow the managers of the firm to be proactive to the changes that are being forecasted, which gives the firm a definite benefit in being able to protect itself through careful planning and preparation.
• On the other hand, fixed budgets do not account for such changes and are too rigid to deal with the sudden changes in activity levels, which may adversely affect the firm.
• Fixed budgets are less complicated to prepare in contrast to flexible budgets, which are much more complex, since they keep changing. However, in today’s ever changing environment the use of a flexible budget seems to be a safer bet than the use of a fixed budget since the future is quite unpredictable given the recent global economic conditions.
Utility (or Importance) of Flexible Budget:
The main importance of flexible budget is that it reflects the expenditure appropriate to various levels of output. The expenditure established through a flexible budget is suitable for comparison of the actual expenditure incurred with the budgeted level applicable for that particular level of activity attained.Following points show the utility or importance of flexible budget:
1. Flexible budget provides a logical comparison of budgeted allowances with the actual cost i.e., a comparison with like basis.
2. Flexible budget reckons operational realities and streamlines control function and profit planning. It gives balanced perspective on comparison. When flexible budget is prepared, actual cost at actual activity is compared with budgeted cost at actual activity i.e., two things to a like basis.
3. Flexible budget recognises concept of variability and provides logical comparison of expenditure with actual expenditure as a means of control.
4. With flexible budget, it is possible to establish budgeted cost for any range of activity.
5. A flexible budget is very useful for purposes of budgetary control because it corresponds with changes in the level of activity.
6. It is helpful in assessing the performance of departmental heads because their performance can be judged in relation to the level of activity attained by the organisation.
7. Cost ascertainment at different levels of activity is possible because a flexible budget is prepared for various levels of activity.
8. It is helpful in price fixation and for sending quotations.
To conclude, a flexible budget is more useful, elastic and practical.
