What is a Flexible Budget? Pros & Cons
It’s no surprise that businesses come up with budgets for their future financial activities for better management. Budgets are compiled using various sorts of data, and their primary goal is to create a probable ledger of expenses and gains in a foreseeable future.
Static budgets are what people usually think of when it comes to budgeting. When creating one, you typically predict how much money you’ll spend or gain each month for upcoming year. It gives you a clear indicator of what to expect, as well as accurate expense volumes to stick by.
Budgets explained
Having a budget for some financial period is critical. Typically, budgets are compiled using historical revenue and losses data, annual growth pace, and other indicators. Possible events in the coming year are also taken into account, as you need a believable depiction of your income level to use in the future.
Obviously, businesses need these to efficiently manage their expenditure & gain accounts. However, it’s also crucial to not exceed the company’s capacity to spend money and, therefore, continue the usual work. Amongst the most important accounts are salaries and modernization efforts. Businesses need to afford these, and if they suddenly can’t, then they need to painfully restructure their expenses.
That’s why accurate budgeting is incredibly important. However, static budgets have some major disadvantages, including:
- Inability to adapt to major changes in the expense/gain balance
- Less potential for maximizing income and minimizing losses
- Projections become obsolete when growth rates outpace the predicted trend.
Well, that’s when a flexible budget model comes into play.
Flexible budget explained
Unlike a static budget, the flexible budget can be adjusted while being used. Although it may seem like having a budget that changes over time slightly kills the point, it doesn’t just change willy-nilly. There’s a system to it and, depending on how you approach your budgeting, there are several types of flexible budgets.
The adjustments are usually applied to a select few accounts, such as revenue, cost of goods, marketing expenses, and so forth. As a result, you won’t easily break your budgeting system by changing everything in it. To be fair, you can change quite a lot, and that’s exactly what different adjustable budget types are about.
Flexible budget types
There are three major types of adjustable budgets. They vary based on the complexity, depth of adjustments, and the number of affected accounts. In all of them, expenses are usually denoted in percentage to current revenue form. So, instead of paying $100,000 of depreciation costs in a particular month, you’ll only have to pay, say, 20% of the revenue.
Basic
The basic adjustable budget can change very little. It’s the most common variation, and this approach is mostly just applicable to some major expenses among those relative to current income.
For instance, if a company decided that it’s going to use 15% of its revenue to pay salaries, then the value of this expense account is going to flex based on how much the company earns. With this method, it’s decided beforehand what corners are going to be cut in case of revenue loss.
Intermediate
While the basic budget takes into account revenue and related accounts, intermediate budgeting can apply to additional entries. It usually takes into account everything the basic approach does, but with additional flexible expenses, such as insurance or rent costs.
In general, the business chooses which accounts to represent based on their projections. The selected accounts can be a special case for the niche, area, or `specific business. Adjusting every account in the budget may not be in the company’s best interest, but selecting a few that need special treatment is a reasonable decision.
For instance, a Californian business can experience rather stable and predictable growth for all of its expenses and gains. However, this state is infamous for unpredictable rent rates, which could be significant enough to pick a flexible budget model specifically for revenue-related expenses and rent costs.
Advanced
The intermediate budgeting method is characterized by picking several special expenditure accounts in addition to (or instead of) revenue-related expenses.
Advanced budgeting, for its part, balances all or most expenses, including income-based and other expenditures. It’s a complex method, and, despite its advantages, it may not be applicable to all businesses. It’s generally good for companies that rely very little on fixed costs.
If that’s the case, advanced budgeting is a must-have. That being said, even basic budgeting may be somewhat complicated to calculate. The advanced method, by comparison, needs some expert accounting. Moreover, if you keep adjusting much of your budget, it gets increasingly difficult to compare the budgets from different periods and draw conclusions from this comparison.