No matter what the size of a company is, businesses need to budget efficiently. Budgeting gives a better picture of earnings and expenses over a particular period.
With the right system in place, you’ll know if your sales goals are on track or whether you’re losing money.
Companies can use several methods to budget, one of which is called a flexible budget. These have several advantages over other budgeting systems, like static ones.
We’ll cover more about flexible budgets in this article, including what they are, how they work, and their advantages and disadvantages.
What Are Flexible Budgets?
Flexible budgets are slightly more complex than static ones, as they allow for changes to occur.
This is ideal in the business world as things can change quickly from one week to the next.
Flexible budgets are a blended financial planning method. These start with a fixed structure, constructed from costs that aren’t predicted to change over the year.
A flexible budget framework is superimposed on top, permitting inconstant costs to waver judging by sales performance.
Instead of allocating everything with a fixed numerical value, flexible budgets tend to use a portion of your planned revenue to cover inconstant costs.
This permits budget changes to happen in the present, with external factors taken into consideration.
If a cost is allocated with a numerical value, a monthly examination of costs paralleled to income permits this value to be adjusted for later intervals.
Generating and maintaining a flexible budget does take more time, but it delivers a very accurate depiction of how your company is performing.
As these allow real-time changes to happen, these results deliver impressive detail and precision once the year ends.
Once each set period or month ends, you can compare the actual earnings alongside the projected earnings, then make adjustments for the next month as needed.
This permits a mutually beneficial connection between the two values.
How Do Flexible Budgets Work?
Businesses can be affected by several different factors, including weather, technology, and economic conditions.
Unfortunately, no one can predict what will happen in the future, so it’s difficult to foresee what the costs will be once the next six months pass.
Flexible budgets have an advantage here, as they make it less stressful to foresee forthcoming conditions.
Generating flexible budgets start with allocating every fixed cost with a stable monthly value. The earning percentage is then worked out and designated to the inconstant expenses.
Flexible budgets are active frameworks that permit growth and contraction to occur in the present.
These keep in mind that businesses are living, expanding structures and that predicting the future is difficult.
Another advantage of flexible budget systems is that if your demand increases, the price of products sold can be altered using a prearranged percentage, as long as you have the money to complete each order.
Example
For instance, if your business anticipates that five components priced at $5 each will sell every month, you can predict earnings of $25 per month.
If we presume that it takes a dollar to create each unit, you’ll need to budget $5 every month for production costs.
Now let’s picture the item going viral on social media, reaching high popularity levels overnight.
The demand increases to 20 components the following month, meaning production costs will increase to $20.
The issue here is that you’ve only budgeted $5 for production costs in the past. Flexible budgets can help you here, as they explain the expense increase judging by the actual earnings made.
If you were using another budgeting system, such as static budgets, you would have been placed in a difficult predicament, which isn’t the best situation for new startups!
However, even though flexible budgets do have their advantages, they also have their shortcomings.
As noted earlier, creating flexible budgeting systems takes a lot of time and effort. Maintaining them needs persistent attention and development.
Costs and earnings also need to be paralleled every month, while notes and changes need to occur.
As flexible budgets are ever-changing, they can, to some extent, lack reliability and responsibility.
When Are Flexible Budgets Beneficial?
Many businesses can gain from implementing flexible budget systems. These make it easy to display if monthly costs were greater than expected, sales were too, which warrants the price increase.
They also make it possible to review the monthly notes and changes to plan for later costs.
It’s best to save flexible budget systems for startups with several variables, like production.
They are also good for businesses that base their earnings on the season, as demand will have a direct effect on costs.
Flexible budgets let you closely examine cost vs earnings, and they also give you the chance to practice situations to see what might and might not work, all without uncompromising financial restrictions.
Advantages And Disadvantages Of Flexible Budgets
Every budgeting framework has its pros and cons, and that includes flexible budgets.
It takes a lot of time to produce and look after flexible budgets, as you’ll have to carry out regular edits and reviews every month.
It’s also a good idea to ask for liability for every change made to the budget, so it keeps functioning well.
Flexible budgets don’t repair deviations, but they can help you prepare for the future. Earnings will still be worked out once the month finishes, so expenses will not be able to change from the past.
Here are some of the main advantages and disadvantages of flexible budgets.
Advantages Of Flexible Budgets
- More realistic as you can adjust expenses connected with earnings
- Can account for greater variances that may occur after greater demand
- Costs are linked with your earnings so you can move towards automating the budget
- Gives you scope for unexpected future changes
- Let you examine several scenarios if unsure about the predicted earnings
Disadvantages Of Flexible Budgets
- The link between earnings and costs doesn’t always have a 1:1 ratio, so the budget might be inaccurate at times
- Isn’t ideal if your expenses aren’t directly linked to your earnings
- Generating and sustaining flexible budgets takes a lot of time and effort
Conclusion
Flexible budgeting can be great for businesses whose expenses are directly related to their earnings.
However, if another budgeting method works for your company better, don’t feel obligated to switch to a flexible budgeting system!
The most important thing is that you keep tracking your finances with a budgeting framework that suits you.
If you enjoyed this article, you might enjoy our post on ‘How Much Money Is A Stack?‘.
