Flexible Budgeting: Advantages & Explanation

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  • 0:03 What Is Flexible Budgeting?
  • 0:18 The Flexible Budgeting Process
  • 1:59 Advantages of Flexible Budgets
  • 2:52 Lesson Summary
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Lesson Transcript
Instructor: Carol Woods

Carol has taught college Finance, Accounting, Management and Business courses and has a MBA in Finance.

What is flexible budgeting? Well, it certainly has nothing to do with being able to touch your toes! It's a way of budgeting that gives better feedback on company performance when sales or production volume is different than what was originally anticipated.

What Is Flexible Budgeting?

In flexible budgeting, a budget has scenarios for different potential volume levels. During the year, a company compares its actual results to the budget scenario that's most appropriate based on the actual volume of activity.

The Flexible Budgeting Process

The process of preparing a flexible budget is very similar to the traditional static budget process. Let's assume that you are a small business owner and need to prepare a budget for your aquarium company for the next fiscal year. In the past, you've had years where you received a few large orders that made it look like you were over budget in almost every category and other years where volume was short and you wondered if the decreases in operating costs were appropriate for the change in volume. So, you've decided to give flexible budgeting a try this year instead.

The first step is to prepare a budget at your most likely sales level. Let's say you anticipate selling 50 of your large aquariums next year. They sell for $1,000 each and cost you $550 each to produce. So, you predict you'll have sales of $1,000 x 50 units, or $50,000, and costs to produce them of $550 x 50 units, or $27,500. In addition, you have rent expenses of $6,000 for the year and selling costs of $12,000.

Now, when you think back to prior years, in a bad year you might only sell 40 units. In a good year, 60 would be possible. So now, you create budget scenarios at the 40- and 60-units level of sales. When sales changes, your cost of production will change also, but your rent doesn't change. In this case you are also paying a flat rate to a part-time sales person, so selling costs won't vary either.

As you start the year, you'll compare your actual results against the 50 units most-likely scenario, but if things change and another scenario becomes more likely, you'll switch to one of the other budget scenarios so that your comparisons are more accurate.

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