In this article we will discuss about:- 1. Meaning of Flexible Budget 2. Importance of Flexible Budget 3. Steps in Preparation 4. Disadvantages.
Meaning of Flexible Budget:
Flexible budget is a budget which, by recognizing the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover, or other variable factors, etc. It is designed to change in relation to the level of activity actually attained. A flexible budget is one that takes account of a range of possible volumes.
It is sometimes referred to as a multi-volume budget. The range of possible outputs may be known as the ‘relevant range’. Flexing a budget takes place when the original budget is deliberately amended to take account of change activity levels. The flexible budget is based on the fundamental difference in behaviour of fixed costs, variable costs and semi-variable costs.
Since fixed costs do not vary with short-run fluctuations in activity it can be seen that the flexible budget will really consist of two parts: The first is a fixed budget being made up of fixed costs and the fixed component of semi variable costs. The second part is a truly flexible budget that consists solely of variable costs.
Importance of Flexible Budget:
Flexible budgets are important aids to decision making which help the management in the following ways:
(i) Flexible budget enable an organization to predict its performance and income levels at a given range of sales levels and activity levels. It can be seen the impact of changes in sales and production levels on revenue, expenses and ultimately income.
(ii) Flexible budgets enable more accurate assessment of managerial and organizational performance.
Steps in Preparation of Flexible Budget:
The steps involved in preparation of flexible budget are as follows:
(a) Specify the time period that is used.
(b) Classify all costs into fixed, variable and semi-variable categories.
(c) Determine the types of standards that are to be used.
(d) Analyze cost behaviour patterns in response to past levels of activity.
(e) Build up the appropriate flexible budget for specified levels of activity.
Disadvantages of Flexible Budget:
The procedure for drawing up a flexible budget is quite straight forward. The flexed budget is only accurate, if costs behave in a predicted manner. All too often assumptions are made about cost behaviour which are too simplistic and hence do not reflect what actually happens.
(a) Flexed budgets assume linearity of costs and, therefore, take no account of, for example discounts for bulk purchases of materials. ‘Labour’ costs are unlikely to behave in a linear fashion unless a piecework scheme is in operation.
(b) Such budgets also rely on the assumption of continuity when costs may actually behave in a stepped or discontinues manner.
(c) The method of determining the fixed and variable elements of costs is often arbitrary and hence the flexed cost bear little relation to the correct budgeted cost for the flexed level of activity.
(d) Although flexed budgets tend to maintain fixed costs at the same level whatever the level of output/sales, very often fixed costs are actually fixed only over a relevant output range.