Flexible Budgeting 101: What Is It & How Does It Work?
Let’s face it – business moves fast, and we have to be flexible for what is thrown at us.
More often than not, our budgets should be just as flexible as we are.
But is the flexible budget model right for you?
We’ve previously covered the five different types of budget models that businesses can choose from. The flexible budget offers the most customizable experience, allowing it to be easily adopted by many different businesses.
Let’s take a more detailed look at flexible budgets.
Table of contents:
- What is a flexible budget?
- How does flexible budgeting work?
- When should you use a flexible budget?
- Pros and cons of flexible budgeting
What is a Flexible Budget?
The more sophisticated relative of the static budget model, a flexible budget allows for change, and as we’ve said – business can be unpredictable.
A flexible budget is kind of a hybrid approach to financial planning. It begins with a static framework built from the costs that are not anticipated to change throughout the year. Layered on top of that is a flexible budget system allowing for variable costs to fluctuate based on sales performance.
A flexible budget often uses a percentage of your projected revenue to account for variable costs rather than assigning a hard numerical value to everything. This allows for budget adjustments to occur in real-time, taking into account external factors.
Even if a cost is assigned a numerical value, a monthly review of costs compared to revenue allows that number to be changed for future periods.
A flexible budget, while much more time-intensive to create and maintain, offers an incredibly precise picture of your company’s performance. Due to the ability to make real-time adjustments, the results present great detail and accuracy at the end of the year.
After each month (or set period) closes, you compare the projected revenue against the actual revenue and adjust the next month’s expenses accordingly. This allows for a more symbiotic relationship between the two.
How Does a Flexible Budget Work?
Accepting that we can’t predict the future, as hard as we might try, is a lesson everyone learned in recent years.
Without psychic abilities, how can you guarantee what your costs will be six months from today? Will your business be impacted by weather, technology, or a worldwide pandemic? Who knows!
Flexible budgets work by taking the pressure off to predict future happenings.
Creating a flexible budget begins with assigning all static costs a fixed monthly value, and then determining the percentage of revenue to assign to your variable costs.
Flexible budgets are dynamic systems which allow for expansion and contraction in real time. They take into account that a business is an organic, growing system and that life is not predictable.
With a flexible budget model, if your demand suddenly triples, your cost of goods sold (COGS) can be adjusted by a predetermined percentage ensuring that you have the cash to fill these orders.
For example, if your business predicts that five units will sell per month at $5 each, you can expect a revenue of $25 a month.
Now, let’s assume that it costs one dollar to make each unit of product, so you budget $5 a month for this.
Imagine your product goes viral on social media and gains unexpected popularity overnight, now there is a demand for 20 units next month, which would cost $20 to make.
The problem is, you have only budgeted $5 a month. This is where a flexible budget comes into play justifying the cost increase based on the actual earned revenue.
In this case, another budget model, say static budget, would have backed you into a corner and left money sitting on the table – not the best feeling especially for a startup!
While flexible budgets sound like the perfect budgeting solution, they do have their drawbacks.
As mentioned before, this model is a much more hands on and time consuming process requiring constant attention and recalibration.
Revenue and cost needs to be compared monthly and adjustments or notes should be made. Additionally, flexible budgets have a lack of accountability to some degree since they are so fluid and open to change.
When is a Flexible Budget Useful?
A lot of companies can benefit greatly from using a flexible budget model.
With a flexible budget, it’s easy to show that while costs for a month might have been much higher than budgeted, so were sales – justifying the increase. You can also study the monthly adjustments and notes to more accurately plan for future costs.
Flexible budgets are best used for startups that have a number of variables such as manufacturing, and others that have revenue based on seasonality, as costs are directly impacted by demand.
Flexible budgets offer close monitoring of expenses versus revenue, and they allow for the opportunity to test things out and see what might work and what won’t without rigid financial constraints.
What Are the Pros and Cons of Flexible Budgets?
All of the different budget models have their benefits and drawbacks – even flexible budgets…as amazing as they sound.
Flexible budgets take time to maintain, with routine monthly reviews and edits. It’s also important to request accountability for all changes made to this budget in order to keep it working for you.
Flexible budgets do not fix variances, they help to better plan for the future. Revenue is still calculated at month end so costs cannot be retroactively adjusted.
Instead, the hope is that patterns will be observed making future cost planning easier and more accurate. In addition, a flexible budget can successfully justify increases in costs when compared to actual income.
Here’s a quick punch list of the pros and cons of flexible budgets.
Flexible Budget Pros:
- Flexible budgets are more realistic – they allow you to adjust the costs associated with your revenue as you grow.
- They are, well – flexible!
- This budget model can justify large variances which may have occurred because of increased demand or other external factors.
- You can work towards automating your budget since your expenses are directly tied to your revenue.
- Unsure about what the future holds? Us too! A flexible budget gives you wiggle room for the unexpected and unknown.
- A flexible budget model allows you to analyze multiple scenarios when you are unsure how much revenue you will generate.
Flexible Budget Cons:
- There isn’t always a 1:1 correlation between revenue and your variable expenses, so the budget won’t always be accurate.
- If your expenses aren’t directly related to revenue, this budget model probably won’t work for you.
- Creating a flexible budget is a lot of work and requires a great deal of time to develop and maintain.
Be Flexible with Finmark
No matter which type of budget model you choose, tracking your finances is what matters most.
If you don’t want to spend hours tracking and forecasting your budget in spreadsheets, check out our financial modeling tool. Finmark is everything you need to build an accurate, customized financial model.
You can get started with a free 30-day trial. Try it today.