Thursday, 13 December 2018

What is 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 a static 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 fix costs are approximately $40,000 per month.

Typically, the production equipment operates between 4,000 and 7,000 hours per month.

Base 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 require 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).

The equipment is require 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).

The plant manager is require 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 reduce. In short, the flexible budget provides a better opportunity for planning and controlling than does a static budget.

Fixed Budget vs Flexible Budget

The 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. A Fixed budgets are more suitable for businesses. That operate in a less dynamic business environment. Whereas flexible budget is 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. Yet since the scenarios consider are greater in number. The accuracy of a flexible budget can be easily affect owing to the variability of the business environment the firm is in.

Flexible budgets are mostly prefer by firms because they allow the firm to conduct scenario planning and better adjust for un-expect situations.

    • Flexible budgets reflect the levels of business activity and output to be produce in line with the changes in the business environment. Whereas flexible budgets are prepare on the assumption that the future of the business will not be much different from its past.

    • The Flexible budgets allow the managers of the firm to be proactive to the changes that are being forecast. 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 complicate 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 seeing to be a safer. Than the use of a fixed budget since the future is quite unpredictable gives 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 establish through a flexible budget is suitable for comparison of the actual expenditure incur with the budget level applicable for that particular level of activity attain.

Following points show the utility or importance of flexible budget:

  1. Flexible budget provides a logical comparison of budget allowances with the actual cost i.e., a comparison with like basis.

  2. The budget reckons operational realities and streamlines control function and profit planning. It gives balance perspective on comparison. When the budget is prepares, actual cost with actual activity will be compare with budget cost.  At actual activity i.e., two things to a like basis.

  3. The budget recognizes 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 budget cost for any range of activity.

  5. 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 judge in relation to the level of activity attain by the organization.

  7. Cost ascertainment at different levels of activity is possible because a  budget is prepare for various levels of activity.

  8. It is helpful in price fixation and for sending quotations.

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