Improving Budgeting using Flexible Budgets
Category: Financial Control Management
Static budgets are prepared for a single, planned level of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity.
That is why sometimes is difficult to evaluate how much of the favorable cost variance is due to lower activity, and how much is due to good cost control?
To answer the question, we must flex the budget to the actual level of activity.
The concept of Budgeting through Flexible Budgets is: if the level of activity for the period is known, there is possible to find out what costs and revenue should have been.
To flex a budget for different activity levels, we must know how costs behave with changes in activity levels.
• Total variable costs change in direct proportion to changes in activity.
• Total fixed costs remain unchanged within the relevant range.
• The result of flexing the budget is the possibility to compare budgeted figures with actual results.
The Flexible Budgets have the following advantages:
• Show revenues and expenses that should have occurred at the actual level of activity.
• May be prepared for any activity level in the relevant range.
• Reveal variances due to good cost control or lack of cost control.
• Improve performance evaluation.