Flexible Budget
A dynamic financial plan that adjusts expense expectations based on actual activity levels, enabling more meaningful performance evaluation than static budgets.
Flexible Budget
A dynamic financial plan that adjusts expense expectations based on actual activity levels, enabling more meaningful performance evaluation by separating volume-related variances from true operational efficiency or inefficiency.
For instance, a manufacturing company budgeted for 10,000 production units with variable costs of $12 per unit and fixed costs of $300,000, totaling $420,000. When actual production reaches 11,000 units, rather than comparing actual costs to the original $420,000 budget, a flexible budget would adjust to $432,000 (variable costs of $132,000 plus fixed costs of $300,000), providing a more relevant benchmark.
Unlike static budgets that remain unchanged regardless of output fluctuations, flexible budgets recognize that many costs naturally vary with activity levels. The approach requires distinguishing between fixed costs (unchanged within relevant range) and variable costs (changing proportionally with activity), then establishing cost behavior formulas. Performance evaluation compares actual costs to the flexible budget appropriate for actual output, revealing genuine efficiency variances rather than those merely reflecting volume differences. This method proves particularly valuable in manufacturing, healthcare, service businesses, and other environments where output variations significantly impact resource consumption and resulting costs.