Use of flexible budgets to analyze performance

A flexible budget performance report is used to compare actual results for a period to the budgeted results generated by a flexible budget. This report varies from a traditional budget versus actual report, in that the actual sales figure is plugged into the budget model, which then uses formulas to alter the budgeted expense amounts. This approach results in budgeted expenses that are significantly more relevant to the actual performance that an organization experiences.

If the flexible budget model is designed to adjust to actual sales inputs in a reasonable manner, then the resulting performance report should closely align with actual expenses. This makes it easier to spot anomalies in the report, which should be rare. Management can then focus on the significant variances to see if any actions should be taken to ensure that actual results remain close to expectations.

The flexible budget model and its related reports are a significant improvement over the more common static model, where there is only one version of a budget, and that budget does not change. When a static model is the basis of comparison, the likely outcome is large favorable variances or unfavorable variances for many line items, since the static model may have been based on a sales level that is no longer relevant to actual conditions.

There are three common types of flexible budgets as follows:

Intermediate Flexible Budget: There are some expenses that do not vary with revenue, instead, they vary based on some other measure such as electricity expense based on the number of units consumed. An intermediate flexible budget takes into account changes in expenses based on such other activity measures as well.

Basic Flexible Budget: In this budget, those expenses that vary with revenue are expressed as a percentage of sales or as cost per unit and adjusted as the output level changes.

Advanced Flexible Budget: Further there are expenses that remain the same in a certain level of activity and beyond such a level they change. An advanced flexible budget takes into account the change in expenses based on the change in such levels.

The flexible budget responds to changes in activity, and may provide a better tool for performance evaluation. It is driven by the expected cost behavior. Fixed factory overhead is the same no matter the activity level, and variable costs are a direct function of observed activity. When performance evaluation is based on a static budget, there is little incentive to drive sales and production above anticipated levels because increases in volume tend to produce more costs and unfavorable variances. The flexible budget-based performance evaluation provides a remedy for this phenomenon.

Flexible Budgets for Planning

The flexible budget illustration for Mooster’s Dairy was prepared after actual production was known. While this tool is useful for performance evaluation, it does little to aid advance planning. But flexible budgets can also be useful planning tools if prepared in advance. For instance, Mooster’s Dairy might anticipate alternative volumes based on temperature-related fluctuations in customer demand for ice cream. These fluctuations will be very important to production management as they plan daily staffing and purchases of milk and cream that will be needed to support the manufacturing operation.