Flexible Budget Variance Analysis: Beginner’s Guide

To prepare a flexible budget, you need to have a master budget, really understand cost behavior, and know the actual volume of goods produced and sold. It helps you identify the underlying causes behind variances (differences between projected and actual figures) and then create a reasonable plan of action. Thereafter, prepare a flexible budget for single or multiple activity levels. Variances or differences in the actual budget give a small business important information about performance elements such as overhead costs and profit.

  • However, compared to static budgeting, it doesn’t fix all target costs.
  • Let’s say your cloud hosting expense increased because several of your smaller customers grew exponentially and are now storing more data in your platform.
  • The ability to provide flexible budgets can be critical in new or changing businesses where the accuracy of estimating sales or usage my not be strong.

In this, one prepares different budgets for varied activity levels. Among all, the one closer to the actual activity is to be considered. After that, one needs to analyze the performance and cost analysis by comparing both. Let’s say Green Company estimates their total production capacity to be 250,000 units. The direct material and labor costs per unit are $4.50 and $2.50 respectively.

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If Connie’s Candy produced 2,200 units, they should expect total overhead to be $10,400 and a standard overhead rate of $4.73 (rounded). In addition to the total standard overhead rate, Connie’s Candy will want to know the variable overhead rates at each activity level. Companies develop a budget based on their expectations for their most likely level of sales and expenses. Often, a company can expect that their production and sales volume will vary from budget period to budget period.

Often, explanation of this variance will need clarification from the production supervisor. Another variable overhead variance to consider is the variable overhead efficiency variance. A company makes a budget for the smallest time period possible so that management can find and adjust problems to minimize their impact on the business. Everything starts with the estimated sales, but what happens if the sales are more or less than expected? What adjustments does a company have to make in order to compare the actual numbers to budgeted numbers when evaluating results?

  • A flexible budget is a budget that adjusts to different levels of activity or output.
  • Use this as a guide to help you build a flexible budget variance analysis in excel.
  • The company knows its variable costs per unit and knows it is introducing its new product to the marketplace.
  • Now that you’ve interpreted each line item, it’s time to calculate the budget variance percentages to flag any significant variances for further investigation.

Dividing total cost of each category by the budgeted production level results in variable cost per unit of $0.50 for indirect materials, $0.40 for indirect labor, and $0.40 for utilities. Flexible budgeting performance report analyzes actual results against the standard budgets. If you have a positive variance, the company produced favorable results and achieved more than it had originally planned.

What is a flexible budget variance?

Flexible budgeting considers both fixed and variable costs with variance analysis. Management may set flexible targets to cover fixed costs and then financial analysis example gradually build on profits later. Variable costs assigned to sales activity or in percentage terms provide greater flexibility in profit analysis.

Flexible Budget Variance Analysis: Beginner’s Guide

A flexible budget created each period allows for a comparison of apples to apples because it will calculate budgeted costs based on the actual sales activity. Typically, static budgets considered a fixed cost and set targets to achieve those results within the available resources. Management may decide to increase or decrease production levels depending on sales targets and a variety of other factors. At that point, the static budget acts as a starting point for the flexible budgeting approach. The revised budget can be compared with actual results to analyze realistic variances. Since revenues and variable costs vary directly with number of units, we need to calculate budgeted price and variable costs per unit by dividing static budget amounts by 30,000 budgeted units.

Either way, establishing a threshold for your budget variance helps with analysis. You can spend more time investigating and addressing the variances that were higher than you wanted. Variance can occur because your business performed better or worse than expected.

Identify Variances

If you don’t have a lot of cash reserves, you may choose to stay on the safe side and aim to keep your variances under 5%. But if your project ends up costing $28k (40% higher than expected), then you may want to dig deeper and figure out what caused the difference. This formula will add all of the numbers in the specified cells. Sum each budget category and the totals in each column using the sum function. Mark P. Holtzman, PhD, CPA, is Chair of the Department of Accounting and Taxation at Seton Hall University. He has taught accounting at the college level for 17 years and runs the Accountinator website at , which gives practical accounting advice to entrepreneurs.

Practically, managers widely use this type of budget as it is the most realistic one. At first, you need to analyze the range under which the activity is expected to fluctuate. The flexible budget supersedes the limitations of a fixed budget. Because it is a practical approach that is suitable for dealing with real-life situations.

On the other hand, supervisory salaries, rent, and depreciation are fixed. Steve recomputes variable costs with the assumption that the company makes 125,000 units. 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.

The total variable overhead cost variance is also found by combining the variable overhead rate variance and the variable overhead efficiency variance. By showing the total variable overhead cost variance as the sum of the two components, management can better analyze the two variances and enhance decision-making. A flexible budget flexes the static budget for each anticipated level of production. This flexibility allows management to estimate what the budgeted numbers would look like at various levels of sales. For example, a flexible budget model is designed where the price per unit is expected to be $100. In the most recent month, 800 units are sold and the actual price per unit sold is $102.

This makes a flexible budget a powerful performance evaluation tool. A flexible budgeting approach is more realistic and practical than a static budget. It provides flexible targets for management with achievable results. You should perform a flexible budgeting variance analysis for each activity to gain valuable information on discrepancies in planning and operations. The original budget assumed 17,000 Pickup Trucks would be sold at $15 each.

If, however, the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance. External factors, such as changes in economic conditions, can also account for budget variances. If one of your main competitors goes out of business, that may lead to favorable variance where you gain customers and have higher revenue than expected. Unfavorable variance, on the other hand, occurs when your real performance is worse than you anticipated. If you have higher actual costs or lower revenue than expected, then you have unfavorable variance.

If actual revenues are inserted into a flexible budget model, this means that any variance will arise between budgeted and actual expenses, not revenues. Budget variance refers to the differences between the figures you projected in your budget and your business’s actual performance. You can calculate variance for any of the line items in your budget, such as revenue, fixed costs, variable costs, and net profit. Figure 8.5 shows the connection between the variable overhead rate variance and variable overhead efficiency variance to total variable overhead cost variance. For instance, management may consider adjusting the sales price by 1 to 3% to generate excess revenue.

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