What is a flexible budget variance?

Not to mention – having a solid overview of your budget performance is non-negotiable if you want to stay in control and hit your goals. Connected to that, flexible budget variance is all about comparing the results you expected from your flexible budget to what has actually happened. It’s a way to see how closely your business’s performance matched the adjusted forecast. Analyzing variance results is a nuanced process that goes beyond simply identifying whether variances are favorable or unfavorable.

Review and Analyze the Variances

However, the company ended up acquiring 1,200 customers, and the actual CAC was $55. The direct material and labor costs per unit are $4.50 and $2.50 respectively. Variance analysis can help management understand the cost drivers and causes of the change whether the change is positive or negative.

By analyzing the variances between actual and budgeted costs, organizations can gain insights into the efficiency of each department’s operations. This information is instrumental in identifying areas for improvement and optimizing resource allocation. This type of variance occurs when actual costs exceed the budgeted costs, leading to potential challenges in achieving financial goals. It can stem from various factors such as unexpected increases in expenses, inefficiencies in production processes, or market fluctuations. The calculation of flexible budget variance involves comparing the actual costs incurred with the standard costs specified in the flexible budget, providing a comprehensive assessment of financial performance.

Budgeting Process: Steps and Best Practices for Planning a Budget

New flexible budgeting provides greater advantages compared to static budgets, there are some limits involved as well. Typically, static budgets considered a fixed cost and set targets to achieve those results within the available resources. The activity level in the equation may refer to various cost drivers affecting the variable costs such as direct materials, labor hours, or sales commission. Creating a second, flexible budget allows a company to evaluate its actual performance during the static budget period.

That means that you need to compare actuals not to your most recent version of the budget (which will have already updated itself to reflect actual projections) but to the original budget you created. You’ll want to get all of your data in a single place to make performing flexible budget variance analyses on a regular basis a much simpler and less painful process. But what if the cloud hosting expense increased because of a price hike on the part of your vendor? Now you’re looking at a higher operational cost with no additional revenue benefit. Variance analysis is essentially digging into the causes behind differences between budgets and actual spending.

Retail Company

Because it is a practical approach that is suitable for dealing with real-life situations. Scan through your data (or the variance report in the financial modeling tool of your choice) and identify the instances of variance you’d like to dig deeper into. This is why analyzing variance in a flexible budget is of critical importance. Now, because you’re using a flexible budget, this additional cost is already anticipated in the budget, so you’re good from that perspective. But you probably still want to know why the hosting cost went up and whether you need to make adujstments. Let’s consider a fintech company that budgeted for 1,000 customer sign-ups with a budgeted customer acquisition cost (CAC) of $50 per customer.

Static budgets don’t allow for making changes in the variables based on a change in activity level. If a business changes its production level, its variable cost will change as well. The flexible budget shows the budgeted items from the static budget, including the cost and the expected sales, compared to the actual results. This example shows how flexible budget variance helps in understanding financial performance beyond static expectations. It allows the management to compare actual performance with the budgeted figures, highlighting areas where the organization has performed better than expected. This can lead to a deeper understanding of the factors contributing to the positive variance, aiding in identifying best practices and areas for potential improvement.

Flexible budget variances may be used to determine any shortcomings in actual performance during a given period. Flexible budget variances are simply the differences between line items on actual financial statements with those on flexed budgets. Since the actual activity level is not available before the accounting periods closes, flexed budgets can only be prepared at the end of the period. A flexible budget model, which is used to create a flexible budget, consists of formulas that generate expected costs based on assumptions used to create the master budget. Any difference between the flexible budget and actual costs and revenue is referred to as a flexible budget variance.

The company acquired 200 more customers than budgeted, leading to an unfavorable efficiency variance of $10,000, flexible budget variance because it had to spend more on customer acquisition than initially planned. At its core, flexible budget variance is about comparing your original budget with what you’ve actually spent or earned. Think of it as a way to get a clearer picture of how your business is really doing. Management may also adjust sales prices to achieve the favorable variance as long as it doesn’t affect their competitive edge. Budgets are a financial tool that forecasts business revenue and expenses over a specific period of time.

Think of it as a budget that adjusts itself based on what’s happening in real time. Instead of sticking to fixed numbers, it adjusts based on what’s actually happening. This is why it reflects a business’s true financial situation much better than a fixed budget, because it recalculates based on current performance. The volume variance isolates the difference between actual results and budget projections due to falling short or exceeding sales volume and therefore production. For income items (revenue, contribution margin and operating income in this example), the flexible budget variance is favorable when actual numbers exceed flexible budget numbers and vice versa. For cost items, excess of flexible budget numbers over actual number means favorable variance and vice versa.

How Can Flexible Budget Variance Be Used For Decision Making?

Variable costs may be represented as percentages of some base figure such as number of units or revenue. This variance plays a critical role in providing insights into the performance of different cost elements within an organization’s budget. By comparing actual expenses with the flexible budget, management can identify areas of overspending or underutilization of resources. This analysis is essential for making informed decisions and implementing corrective actions to align actual results with budgetary expectations.

Quantity variance, within the context of flexible budgeting, provides valuable insights into the operational effectiveness and efficiency, driving continuous improvement and cost control efforts. In the above illustration, if the company’s cost per product also increased by $3, there will be an unfavorable variance of $6,000. When both conditions are evaluated together, the company derives a positive value of $4,000, making it a favorable variance for the business. Halfway through the fiscal year, when performing your flexible budget variance analysis, you see that you’ve already spent $13,000, which means you’re pacing towards an annual cost of $26,000. It helps you stay on top of performance by comparing actual results to updated forecasts, which gives you clear insights into how efficiently your business is running. If you dig deep in these variances, you can spot areas that need improvement, make smarter resource decisions, and keep your company on a path to growth and profitability.

The biggest advantage of flexible budgeting is the stress on operational efficiency required to achieve the target. You can use a budget to plan for various activities or departments within a business. Budgets offer planning and control measures for an organization, and will always vary slightly from actual sales and actual output. Flexible budget variance can be calculated by subtracting the actual cost from the budgeted cost for a specific item, then multiplying the difference by the difference between the actual and budgeted activity levels.

This variance helps you understand whether the business is performing better or worse than expected based on actual activity levels. A static budgeting approach would compare the results at the end of the production period as variances cannot be adjusted. With flexible budgeting, you can forecast the difference in margins if all other things remain equal and the variance and margins changes alongside production levels. The flexible budgeting approach helps to narrow the gap between actual results and standards due to activity level changes.

Calculating Flexible Budget Variance – a Practical Example

Favorable variance occurs when actual costs are lower than the flexible budget, indicating efficient resource utilization or potential cost-saving measures. This can positively impact profitability and signal effective cost management. The components of flexible budget variance include price variance and quantity variance, which collectively provide insights into the cost management and variance investigation within an organization. When this company exceeded its budget, breaking the variances into price and efficiency factors helped clarify the situation. The unfavorable price variance came from higher-than-expected customer acquisition costs (CAC), while the efficiency variance reflected acquiring more customers than initially planned.

These projections are not static; they are adjusted based on actual sales and market conditions. This allows businesses to set more realistic financial targets and make informed decisions. For instance, if a company experiences higher-than-expected sales, the flexible budget can be adjusted to reflect the increased revenue, providing a more accurate basis for financial planning. A flexible budget is a valuable tool for cost management because it allows the company to see how costs change as output changes. The flexible budget can also be used to compare actual costs to budgeted costs.

Businesses often face fluctuating conditions that make static budgets less effective. Flexible budgeting offers a dynamic approach, allowing companies to adjust their financial plans based on actual performance and changing circumstances. A flexible budget can be created for any organization, but it is most commonly used in manufacturing. This is because manufacturing generally has more variable costs than other businesses.

— Posted on August 23, 2024 at 2:31 pm by