Meaning, Advantages and Disadvantages of Flexible Budget
Flexible Budget Meaning
A flexible budget consists of a series of budgets for different levels of activity. It, therefore, varies with the level of activity attained. A flexible budget is prepared after taking into consideration unforeseen changes in the conditions of the business. A flexible budget is defined as a budget that by recognizing the difference between fixed, semi-fixed and variable costs is designed to change the level of activity.
According to CIMA, a flexible budget is, “A budget which, by recognizing the difference in behaviour between fixed and variable costs about fluctuations in output, turnover or other variable factors such as several employees, is designed to change appropriately with such fluctuations”.
To prepare and implement a flexible budget, a company must plan how it will respond to changing situations, for example, the sale of 10,000 units instead of 8,000 units or the addition of a new machine or the development of a new product. In other words, the company plans, what the effect will be on revenue, expense and profits if sales and or production differ from the budget.
Flexible budgets are useful in the following cases:
1) When the sales of the firm are difficult or impossible to be predicated.
2) When the level of activity depends upon the supply of any particular input and the supply level of that material/input cannot be predicted.
3) When the firm is dealing with a new product and the sales prediction is difficult.
Features of Flexible Budget
Flexible budgets have several desirable features as follows:
1) Cover a Range of Activity: Forecasts of future events always involve some uncertainty. Managers want to minimize the effect of uncertainty in planning and decision making. Unlike a fixed budget, which provides only one estimate of expected outcomes, a flexible budget reflects expected results for several activity levels. A flexible budget does not reduce the probability that fluctuations in activity levels will occur, but it does provide managers with information about the effect of changes in activity levels.
2) Dynamic in Nature: Flexible budgets allow managers to adjust plans more easily if activity differs from expected levels. With flexible budget data, it is easy to adjust budget estimates on a timely basis to reflect fluctuations from the expected activity level. Such budgets address ‘what is’ rather than ‘what was’ or, ‘what was expected’. This dynamic nature of flexible budgets makes them a very useful decision making tool for management.
3) Facilitate Performance Measurement: An important role of performance reporting is efficiency measurement. A flexible budget is very useful for efficiency measurement.
Advantages of Flexible Budget
The following are the main advantages of a flexible budget:
1) A flexible budget makes it possible to establish the budgeted costs for any level of activity within the relevant range even after the period’s activity is over.
2) A flexible budget helps assess the performance of departmental heads because their performance can be judged by the level of activity attained. A flexible budget is a readymade comparison for cost control.
3) Flexible budget makes it possible to ascertain the cost at various levels of activity. A flexible budget is helpful in price fixation and sending quotations.
4) Flexible budget assists in evaluating the effects of varying volumes of activities on profits and cash position. Flexible budget facilities production planning as well as profit planning.
5) Flexible budget helps in controlling overheads.
Disadvantages of Flexible Budget
The disadvantages of a flexible budget are as follows:
1) Flexible budgets assume linearity of costs and therefore take no account of, e.g., discounts for bulk purchases of materials. Labour costs are unlikely to behave linearly unless a piecework scheme is in operation.
2) Such budgets also rely on the assumption of continuity, when costs may behave in a stepped or a discontinuous manner.
3) The method of determining the fixed and variable elements of costs is often arbitrary and hence the flexed cost bears little relation to the correct budgeted cost for the flexed level of activity.
4) Although flexible budgets tend to maintain fixed costs at the same level whatever the level of output/sales, very often fixed costs are fixed only over a relevant output range.