Flexible Budget Report

Learning Outcomes

  • Create a flexible budget report that shows sales, activity, labor, or cost variances

Jake is now working on a flexible budget for his sales department! His supervisor gave him to green light to keep selling and keep paying his sales people! It looks to be a record year. As he works on his budget, he notices that even though increased sales cause increases in some of the expenses in his department, others, such as rent, stay the same. This makes Jake really happy, as the net profit for his department is rising along with the increase in sales! Let’s take a look at how a flexible budget can help businesses grow, and offer a better picture of where budgeted expenses should be.

In the previous section, we started to talk about how the budget needs to be a fluid document. Flexible budgeting is important for businesses, as the world isn’t static!

The budget we prepared is called a planning budget. This budget is put together before the year starts, and is a static budget. We can’t use it for accessing if costs are being effectively controlled. It doesn’t let us compare apples to apples.

So what if instead of selling 2000 pair of shoes, we sold 3000? Would it be fair to hold our production manager responsible for going over costs when he manufactured 1000 more pair of shoes? The answer to this is obviously no, so how can we fix this problem? On the other hand, if we produce less, and our electricity bill is lower, it would note be fair to give kudos for reducing energy costs!

Flexible budgets take into account how changes in production affect costs. So if production goes up, costs would go up. In converse, if we were to sell fewer shoes, our costs would go down!

So, a flexible budget lets us see what the costs should have been at a particular level of activity. Let’s look at an example:

Planning Budget Flexible Budget Activity Variance Favorable or Unfavorable
Classes taken 500 600
Revenue ($14/class) $7,000 $8,400 $1,400 Favorable
Wages and Salaries $3,500 $4,200 $700 Unfavorable
Yoga Supplies $250 $300 $50 Unfavorable
Utilities $500 $600 $100 Unfavorable
Rent $500 $500
Insurance $100 $100
Other Expenses $250 $300 $50 Unfavorable
Total Expense $5,100 $6,000 $900 Unfavorable
Net Operating Income $1,900 $2,400 $500 Favorable

So let’s look at Simply Yoga. If their planning budget assumed 500 classes to be taken, but there were actually 600 classes taken in the time period, how would expenses react? Well, in this case, it looks like wages area based on a per class cost of $7 [latex]\bigg(\dfrac{\$3500}{500}=\$7[/latex], and so does [latex]\dfrac{\$4200}{600}=\$7\big)[/latex]. So if more classes are taken, it is a favorable revenue variance, meaning the studio made more money, but an unfavorable wages and salaries variance, as they spent more on wages than budgeted. But was it a good thing to spend more? Yes! Even though expenses were higher, the net operating income is higher. So this is a good thing! This flexible budget allows us to make changes in the expense accounts as the number of classes taken changes.

So why did rent and insurance not change? Remember back to our Hupana Running Company example. Those kinds of expenses are fixed, so it doesn’t matter how many shoes we sell or classes are taken, they remain the same. This type of budgeting helps us to see how increases in revenue affect net profit.

Practice Questions